The Bank of Korea plays the “FX stability levy exemption” card, widening the scope of exchange-rate defense

Liquidity safeguards now subject to adjustment
Weight of the reserve requirement “exception”
All-out phase of exchange-rate defense begins

Just one day after announcing a joint adjustment plan for FX stability rules with financial authorities, the Bank of Korea followed up with a series of unusual measures, including exemptions from FX stability levies and easing reserve requirements, signaling a shift in how it approaches exchange-rate management. Over the past year, policy efforts had focused on increasing dollar inflows to stabilize the FX market.

More recently, however, the emphasis has moved toward encouraging financial institutions and companies to make greater use of foreign currency they already hold. Temporarily loosening FX discipline to redirect currency flows is widely seen as an indication of how serious current exchange-rate pressures have become.

Reducing the burden of foreign-currency funding and management

On the 19th, the Bank of Korea convened an emergency Monetary Policy Board meeting at its headquarters in Seoul and approved a plan to exempt domestic and foreign financial institutions from FX stability levies through June next year. Under the current Foreign Exchange Transactions Act, financial institutions are required to pay a levy, calculated as a set ratio, when raising or holding non-deposit foreign-currency liabilities. The system has functioned as a safeguard to curb excessive foreign-currency borrowing and manage volatility in short-term cross-border flows. Temporarily waiving the levy directly lowers foreign-currency funding costs for financial institutions, easing the burden of borrowing and management and potentially increasing the supply of dollars in the onshore FX market.

At the same time, the Bank of Korea decided to pay interest, on a temporary basis, on excess reserve requirements held as foreign-currency deposits. The policy applies to excess reserves accumulated from December this year through May next year, with interest payments made monthly from January to June next year. Until now, the reserve requirement system—under which banks must deposit a portion of customer foreign-currency deposits at the central bank—has effectively tied up funds without interest. By offering interest on excess reserves, the Bank of Korea aims to encourage financial institutions to keep surplus funds domestically rather than deploying them overseas.

The interest rate will be set in reference to the US Federal Reserve’s policy rate target range of 3.50% to 3.75%, minimizing discrepancies with global dollar-rate conditions. This is intended to reduce incentives for banks to move assets offshore due to opportunity costs. Taken together, the measures are interpreted as an effort to limit outward leakage of foreign-currency liquidity while increasing the likelihood that banks attract foreign-currency deposits from corporates and households and supply them into the domestic market. Since actual implementation ultimately depends on individual institutions, however, questions remain over how effective the measures will be.

What “temporary exemptions” reveal about the severity of the situation

Within the financial sector, many note that if similar measures had been applied to won-denominated assets, they would likely have triggered controversies over reserve-ratio adjustments and the credibility of monetary policy itself. That authorities have allowed temporary exceptions in the foreign-currency domain suggests that exchange-rate instability is now viewed as more than routine market volatility, but rather as a broader strain on the financial system. Internal discussions at the Bank of Korea have reportedly reflected both the importance of the legal basis and role of the FX reserve requirement system and the need to reassess its operation amid rising resident overseas investment and growing foreign-currency deposits.

The Bank of Korea has precedent for such exemptions, having temporarily waived FX stability levies for three months during the COVID-19 pandemic in 2020. The renewed attention to that episode underscores perceptions that current FX conditions have entered an emergency phase. Reserve requirement ratios are set at 2% for time deposits, 5% for demand deposits, and 1% for certain exceptions such as external accounts, all of which must be deposited in designated currencies. As these requirements are legally binding rather than advisory, they form a core pillar of foreign-currency liquidity management.

The strictness of the system is evident in past enforcement cases. In 2018, the Bank of Korea imposed an administrative fine of roughly $11m on a financial institution for under-reserving against certain foreign-currency deposits between July 2007 and January 2018. The institution challenged the penalty in court, but the Seoul Administrative Court ruled that the fine constituted a valid administrative action by the Bank of Korea governor and that penalties could be imposed on foreign-currency deposits under the same legal basis as won deposits. The ruling reinforced the view that FX reserve requirements are mandatory, not discretionary, highlighting how tightly foreign-currency liquidity has been regulated. Against that backdrop, the current temporary easing is seen as a clear shift in the central bank’s balance toward supplying market liquidity over preserving institutional rigidity. One financial-sector official commented that the measures suggest the central bank has reached a point where exchange-rate stability is difficult to maintain without mobilizing banks’ foreign-currency management capacity, adding that policy tools appear close to exhaustion.

Depleting monetary and FX policy ammunition

If the joint FX stability adjustment announced the previous day amounted to pressure on companies and major banks to draw down dollar balances, the latest measures read more like reassurance that institutions will not be penalized for doing so. On the 18th, authorities unveiled a plan to temporarily ease penalties tied to foreign-currency liquidity stress tests, making clear that the focus of FX policy had shifted from boosting inflows to utilizing existing balances. The stress-test framework, which requires banks to regularly assess their dollar funding capacity under crisis scenarios, has long been cited as a key constraint on onshore dollar circulation.

The joint measures apply broadly to domestic banks as well as foreign banks and corporates. Authorities raised the forward-position limits of foreign banks’ local subsidiaries from 75% to 200% of capital. As forward positions—the difference between foreign-currency assets and liabilities—increase, banks can supply more dollars to the market. Restrictions on foreign-currency loans for exporters were also eased, expanding their permitted use beyond capital investment to include working capital such as wages and raw-material payments. The goal is to encourage banks and companies to use foreign currency domestically rather than shifting it offshore.

This approach contrasts sharply with policy a year earlier. In December last year, when the won–dollar rate hovered in the mid-1400s, authorities focused on widening inflow channels by raising forward-position limits and easing foreign-currency lending rules. At that time, domestic banks’ forward-position limits were lifted from 50% to 75% of capital, while limits for foreign bank branches were raised from 250% to 375%. The foreign-exchange swap limit for the National Pension Service was also increased from $50bn to $65bn, using reserves as a buffer. Those measures clearly prioritized boosting dollar inflows.

By contrast, the latest joint adjustments and the Bank of Korea’s levy exemptions shift attention to how accumulated foreign currency within the financial system can be deployed. This suggests the FX response has entered a more advanced phase. The challenge is that banks themselves are not in a position of excess comfort, as exchange-rate volatility has also amplified fluctuations in the value of their foreign-currency assets and liabilities. While encouraging banks to release dollars into the market may help dampen short-term volatility, reliance on voluntary decisions raises doubts about the sustainability of the approach over the medium to long term.