Korea Capital Market Institute

Expansionary monetary policy throughout the world has been reshaping Korea’s financial environment in the post-crisis era. Amid the prolonged low interest rate trend coupled with population ageing, domestic bank deposits are losing their appeal whereas money flows to financial investment products aiming at relatively high expected returns are on the persistent rise. On the other hand, the lengthening of global uncertainties including a US policy rate increase has also facilitated rapid money flows between financial industries as well as between financial instruments.
Since the 2000s, it is observed that Korea’s money flows within financial sectors reveal a reduction in the share of depositary institutions, but a rise of securities firms and asset management companies. By type of financial instruments, a decrease was observed in the share of three instrument categories (settlement, marketable, and saving), while the share of investment instruments expanded substantially. Within the investment category, the share of equity funds fell whereas that of bond funds and hybrid funds increases.
In this regard, this study explores the current state and characteristics of money flows across Korean financial institutions and financial instruments, and carries out  empirical analyses on what are the key drivers for the changes in money flows between different categories of financial instruments. Particularly, the focus is placed on how and what changes are caused by expansionary monetary policy of Korea and the lengthening of external uncertainties.
The empirical results based on regression analysis and VAR models show that the impacts of a change in the monetary policy stance and of an increase in external uncertainties on the money flows somewhat differ across financial instruments. First of all, money flows to settlement instruments are found to increase when low interest rates and abundant liquidity continue due to expansionary monetary policy. Saving instruments are mostly affected by expected returns such as the average bank deposit rate, implying that the recent low interest rate trend serves to curtail money flows to saving instruments. However, it is found that any increase in external uncertainties bolsters the preference over safe assets, and thereby pushes up bank deposits. Also found is a strong tendency where money flows to investment instruments pick up with a rally in Korea’s stock market, and diminish as financial unrest reinforces risk aversion. However, the declining bank deposit rate amid low interest rates has only a statistically weak impact on replacing bank deposits with investment instruments.
Given that Korea’s expansionary monetary policy and global uncertainties are likely to continue for the foreseeable future, money flows between financial instruments are expected to become brisker than now. The aforementioned analysis results have the following implications.
First, it is noticeable from the perspective of future monetary policy that the increase in market liquidity and low interest rates supported by expansionary monetary policy merely leads to a rise in short-term floating capital to some extent. This is against the expectation that the market liquidity may flow into the banking sector or financial investment sector, eventually contributing to facilitating direct or indirect financing of businesses. Hence, what is important for the effectiveness of monetary policy is not to cut interest rates further, but to induce market liquidity to be effectively injected into the financial sector as well as productive areas in the real economy. To that end, it is essential to make efforts to narrow the discrepancy between the real economy and the financial sector via decisive restructuring of both corporate and financial firms, etc.
Second, flows to investment instruments have been on the constant increase amid the recent low-interest rate trend. Also, Korea’s rapid pace of population ageing increasingly requires retirement readiness via increases in asset value. Hence, Korea should meet the growing need to facilitate quantitative and qualitative development in the capital markets with the focus placed on the equity and debt markets to better cater to the rising demand for investment instruments and to bolster direct financing to businesses. It is worth mentioning, however, that investment vehicles in nature have the risk of asset price volatility that could significantly affect financial stability. Thus, caution is required to fully manage inherent risks, which would help prevent higher volatility in financial markets, creation of asset price bubbles, and damage to financial stability.
Third, it is desirable to put more efforts to prevent Korea’s money flows from being distorted by a variety of global uncertainties such as a US interest rate hike, variability arising from power transfer in the US, potential currency conflicts with China, rising protectionism, etc. The aforementioned result where any increase in external uncertainties leads to a cut in investment instruments and a shift toward saving deposits requires caution in two areas. The expected shrink in investment instruments should not undermine the vitality of the capital markets. Also, the rise in banks’ credit provision that stems from the increase in long-term savings should not excessively or disproportionately flow into distressed firms, or household loans targeting the real estate market.