South Korea on Thursday announced a plan to oblige banks to raise foreign currency liquidity ratio to prevent potential foreign capital outflows ahead of interest rate hikes in the United States and a referendum on Brexit, or British exit from the European Union (EU). 

Currently, banks are recommended to hold high-quality foreign currency liquid assets, which can easily be converted into cash, at a ratio of 50 percent to total foreign currency exposure that can be withdrawn within 30 days. 

Banks will be obliged to raise the foreign currency liquidity coverage ratio (LCR) to 60 percent from next year. It will be raised by 10 percentage points annually to reach 80 percent by 2019, according to a joint statement from the finance ministry and the financial regulator. 

Policy banks such as the Industrial Bank of Korea (IBK), NongHyup Bank and Suhyup Bank will be required to raise the LCR by 20 percentage points annually from 40 percent in 2017 to 80 percent in 2019. 

State-run Korea Development Bank (KDB) will be obliged to increase the LCR by 10 percentage points from 40 percent in 2017 to 60 percent in 2019, but the Export-Import Bank of Korea (KEXIM) will be exempted from the regulations in consideration of its role as an export credit agency. 

Seoul branches of foreign banks will also be exempted from the obligation as they are already required to hold liquid assets under the Basel III framework. The regulation will not be applied to foreign debts less than 500 million US dollars or banks with foreign debts at a ratio of less than 5 percent to total debts. 

The new regulations came on growing worries that foreign capital may abruptly flow out of the South Korean financial market if the US Federal Reserve hikes rates going forward. The Fed refrained from altering rates at the June rate-setting meeting overnight, but it was widely expected to lift rates as many as twice in the second half of this year. 

The Bank of Korea (BOK), South Korea's central bank, cut its benchmark interest rate by a quarter percentage point to a new record low of 1.25 percent last week. It was the first cut in a year, raising concerns over foreign funds exodus. 

Other external uncertainties remained such as a British referendum on Brexit scheduled for next week. If Britain decides to give up its EU membership, foreign investors would reduce their holdings of local stocks and bonds amid mounting risk-averse sentiment in the global financial market. 

To make banks overcome potential foreign currency liquidity crisis, South Korea will ease regulations on foreign exchange forwards position. 

The ceiling on a ratio of foreign exchange forwards position to equity will be raised to 40 percent for local banks from the current 30 percent starting July. The cap for Seoul branches of foreign banks will be lifted from the current 40 percent to 200 percent. 

It was introduced after the 2008 global financial crisis as part of efforts to prevent banks from increasing foreign debts excessively. Excessive forwards positions led to a surge in short-term foreign debts, which were withdrawn from local banks abruptly and massively in times of financial crisis. 

The regulation was tightened in January 2013 to block an increase in foreign debts, but the first easing since its implementation in 2010 will allow banks' room for borrowing foreign funds in times of liquidity crisis.