When President Yoon Suk-yeol took office in May, he vowed to promote free market principles, unlike his predecessor. In mid-October, Yoon publicly reaffirmed his stance that he is “a believer in a free market economy that respects the freedom and creativity of businesses.”
But in a country where the government’s heavy intervention in the private as well as financial sectors had long been a norm, Yoon has yet to put his money where his mouth is.
The problem is that Yoon may find commercial banks’ interest on deposits to be lower than he expects. Only a few weeks ago, major banks rushed to roll out new fixed deposits with plus-5 percent interest in line with the rising benchmark rates set by the Bank of Korea.
Strangely enough, the new deposit products offering over 5 percent interest disappeared even after the BOK hiked the benchmark interest by 25 basis point to 3.25 percent in a bid to tame soaring prices.
Throughout this year, commercial banks have raised interest on deposits as well as on loans in step with the benchmark rates. One does not need to understand rocket science to see why the two rates move hand in hand in the financial market. After all, interest rates at commercial banks are closely linked to the benchmark rates, and businesses and consumers also expect the rates to go up or down together.
The reason why banks stopped raising interest on fixed deposits above 5 percent is the alleged intervention of the government and financial regulators. From the very beginning of his term, Yoon and top financial officials criticized commercial banks for making huge profits charging high interest rates on their loan products yet relatively low interest on deposits. Their critical remarks acted as pressure on banks to hike interest on deposits at a faster pace.
The Financial Services Commission proposed a new policy that discloses interest gaps between deposits and loans, which went into effect on Aug. 22. To avoid public criticism, commercial banks tried to minimize interest hikes for loans while accelerating the launches of new deposit products with higher interest.
But financial authorities were caught off guard when the so-called Legoland incident led to a sudden credit crunch the financial market. Financial regulators forced commercial banks to refrain from issuing bank bonds in order to tackle the deepening credit crunch, but this led to an inevitable situation in which banks sought alternative source of fresh capital -- fixed deposit products with higher interest.
Commercial banks raised interest on new deposit products to draw more capital, but found it hard to raise rates on loans since the gap is now fully disclosed.
At this point, financial authorities stepped in again, asking banks to stop competing with each other by raising interest rates on deposits, and strengthened monitoring on banks in fears that higher deposit rates would lead to higher loan rates.
The disclosure policy for interest rate gaps at commercial banks has not been well received by banks. First, consumers do not choose new products based on such public disclosure. Second, skeptical views are widespread that such policy cannot force banks from raising interest rates for their products in the long term.
What the government and financial regulators did is nothing if not a sorry demonstration of an inconsistent policy as they put pressure on banks to raise interest on deposits and then forced banks to keep rates artificially lower than the benchmark rates.
Financial authorities justified their move as an attempt to block money from leaving for safer profits such as bank deposits, which in turn sparked a serious liquidity crunch in the broader financial market.
For consumers, especially those who want to shop for fixed deposit products with higher interest reflecting the benchmark rates, the government’s inconsistent financial policy appears both puzzling and disappointing. More importantly, regulators’ apparent distortion of interest rates at banks could eventually backfire, undermining free market principles and bringing lower rates of return to fixed deposit holders. Old habits of the government’s excessive intervention in the financial market die hard; it is time to kill the bad practice, no matter how painful it may be.