Does tight monetary policy threaten the soundness of Korean banks?

Abstract

This study analysed the relationship between the implementation of the Central Bank of Korea's tight monetary policy due to the recent deepening of inflation and the soundness of Korean banks. This study focused on the fact that the recently published research results of Jung (2023) were different from previous research results. The traditional result is that tight monetary policy reduces loan defaults by shrinking banks' lending capacity. However, Jung (2023), who analysed banks in the EU, claims that loan defaults do not increase despite easing monetary policy. This study empirically analysed the risk indicators that evaluate the financial soundness of banks by dividing them into the financial insolvency, financing costs, recapitalization, and risk holding. The research results are as follows. First, tight monetary policy reduces banks' loan defaults in line with Gambacorta and Mistrulli (2004) instead of Jung (2023). Second, banks' financing costs increased due to the tight monetary policy with same context to the claims of Borio and Hofmann (2017) and Jung (2023). Third, banks' recapitalization level actually decreased due to tight monetary policy as argument of Jung (2023). Fourth, tight monetary policy had no significant relationship with banks' risk taking behaviour in consistent with Diamond and Rajan (2011) and Jimenez et al. (2012). In conclusion, tight monetary policy reduces insolvency of loans, but increases potential risk factors such as increased financing costs and reduced recapitalization in the future. Therefore, this study suggests novel findings and policy challenges.