The impact of financial stability policies on Korea treasury bond yields

This paper examines the effects of macroprudential regulations implemented in the Republic of Korea on Korea Treasury bond (KTB) yields. While macroprudential regulations primarily aim to enhance financial stability by mitigating systemic risks, they can also indirectly affect bond market dynamics by altering the demand for safe assets. Specifically, this study analyzes the impacts of two significant financial stability measures introduced in the Republic of Korea following the Global Financial Crisis: restrictions on securities firms' call borrowing and the phased implementation of the liquidity coverage ratio (LCR) for banks. Empirical findings indicate that restricting securities firms' call borrowing to within 25% of their equity capital and subsequently excluding them from the call market substantially increased their demand for KTBs, cumulatively reducing KTB yields by approximately 10.8 to 12.5 basis points. Furthermore, the phased implementation of the LCR regulation increased banks' demand for KTBs, resulting in an additional cumulative decrease in KTB yields of approximately 6.1 to 7.3 basis points. These findings underscore the necessity for policymakers to carefully consider the potential implications for bond markets and broader financial market spillover when introducing or adjusting macroprudential measures.