A plea bargain in the name of “productive finance”

 

Ha Hyun-ock
 
The author is an editorial writer at the JoongAng Ilbo. 
 
 
The Financial Supervisory Service (FSS) has taken a winding and inconsistent path in its handling of penalties tied to the sale of Hong Kong H-index equity linked securities. Its shifting guidance and elastic regulatory posture have unsettled banks, investors and the broader financial market.
 

 
On Nov. 28, the agency issued preliminary notice of 2 trillion won (about $1.36 billion) in fines against five banks for allegedly mis-selling Hong Kong H-index ELS products. The amount would mark the largest penalty of its kind. The figure must still be reviewed by the FSS sanctions committee and later approved by the Financial Services Commission, yet the announcement alone jolted the market. Lee Chan-jin, the FSS governor, said the action was intended to demonstrate the authority’s commitment to consumer protection.
 
Consumer protection is a critical mandate, but banks argue that the unprecedented fine conflicts with earlier signals from the regulator. As losses deepened and compensation discussions intensified last year, former FSS governor Lee Bok-hyun told banks that voluntary, early compensation for investors would be treated as a mitigating factor in future inspections and sanctions. Banks acted accordingly, believing that their cooperation would be taken into account.
 
The losses were severe. After the Hong Kong H-index plunged in 2023, investors faced losses of 4.6 trillion won on a total of 16.3 trillion won in ELS products sold since 2020. The FSS strongly encouraged banks to compensate investors first, which generated controversy. Critics argued that if mis-selling had occurred, the issue should be resolved through formal inspections and legal processes, not by forcing financial institutions toward advance payouts under the banner of consumer protection.
 
Another debate emerged because most of the affected investors were not newcomers. Roughly 91 percent of those who lost money had invested in ELS products before. At a time of low interest rates, the products were widely viewed as medium-risk instruments, familiar to longtime investors. Some observers questioned whether it was reasonable for these investors to claim they had been misled by banks. The regulator’s pressure, they warned, risked weakening the principle of investor responsibility and encouraging moral hazard.
 
 
Even so, expecting mitigation, banks proceeded with advance compensation based on guidelines from the FSS’s dispute-resolution process. Those guidelines recommended reimbursing at least 40 percent of average losses and, in some cases, up to full compensation. By June, banks had reached settlements with 96 percent of affected investors, paying out a combined 1.34 trillion won. But instead of leniency, banks received notice of record fines. For financial institutions, it felt as though trust in the regulator had yielded punishment rather than fairness.
 
Three days later the message shifted. At a press briefing on Dec. 1, Gov. Lee said the FSS would take banks’ remedial efforts fully into account when determining the penalty ceiling with the Financial Services Commission. He also suggested potential easing of capital rules linked to fines. The turnabout coincided with the Lee Jae Myung administration’s push for “productive finance,” a policy encouraging large financial groups to expand lending to businesses and make greater investments in risk capital. Korea’s five major financial holding companies have pledged to direct 508 trillion won into productive sectors over the next five years. Heavy fines, however, threaten to constrain that commitment.
 
Fines can hinder productive finance by increasing a bank’s risk-weighted assets. Those assets rise when high-risk exposures are added to a bank’s balance sheet, and the higher the total, the more capital the bank must retain. Increased requirements reduce a bank’s lending capacity and limit its flexibility in dividends and shareholder returns.
 

 
The risk weight for fines is particularly burdensome, ranging from 600 to 700 percent. Once a fine is imposed, banks must record six to seven times the penalty amount as operational risk for as long as 10 years. If the fine is ultimately confirmed at 2 trillion won, risk-weighted assets would rise by 12 trillion to 14 trillion won. This comes at a time when the regulator is encouraging banks to expand lending to companies by tightening the risk weight on mortgage loans and shifting credit capacity toward business sectors. The potential impact of the fines effectively clashes with the government’s own policy direction.
 
The back-and-forth has weakened trust in the FSS. The agency encouraged early compensation with promises of leniency, then appeared to reverse course and threaten heavy sanctions. Now it is attempting to soften penalties and adjust rules. The broader concern is regulatory inconsistency. Standards that stretch and contract without clear justification undermine confidence in the supervisory framework.
 
More troubling is the use of capital regulations — meant to ensure the sound management of financial institutions — as tools of economic policy. The process increasingly resembles a plea bargain, even though no party is admitting guilt in exchange for reduced penalties. A regulator responsible for policing mis-selling now risks mis-selling its own rules. In a system where predictability and fairness are essential, such inconsistency poses a danger not only to the credibility of the regulator, but also to the stability of the entire financial market.

This article was originally written in Korean and translated by a bilingual reporter with the help of generative AI tools. It was then edited by a native English-speaking editor. All AI-assisted translations are reviewed and refined by our newsroom.