A Study on Potential Effect of Introducing Covered Bond onto Korean Deposit Insurance Fund

This study aims to analyze the potential impact of issuing covered bonds (CBs) on the other creditors of issuer banks and the Korean Deposit Insurance Fund. 『Act on Issuance of Bonds with Dual Recourses』(CB Act) enforced on April this year introduces statutory covered bonds in Korea. When the domestic banks issue CBs, the Korean Deposit Insurance Fund (KDIF) might be expected to suffer loss in some cases according to simple stress test; the expected loss (EL) in this study shows that the EL may not be under control if issuers' asset deterioration become over certain level. Furthermore, a CB issuer bank has the duty to maintain the eligibility requirement for underlying assets (so-called cover pool) making the KDIF more vulnerable to an economic shock as the KDIF has to pay deposit holders if the issuer bank defaults, which will force the injection of money by the Korean government. On the other hand, it is doubtful whether the current CB Act is cautiously taking into consideration the negative external impact of issuing CB on the KDIF. Therefore, the Korean government should try to recognize the all potential effects (external diseconomy) and to take care of every aspect of issuing CB, thereby reshaping and/or fine-tuning the current CB Act.