The financial authorities will soon instruct banks to slash their forward trading, as part of government measures to crack down currency speculation by regulating foreign exchange positions.

The Ministry of Strategy and Finance and the Bank of Korea said on Thursday that they have decided to order banks dealing with foreign currency trading to reduce the ceiling of forward trading by about 20 percent.

Under the new regulation, foreign bank branches in Korea will see the ceiling fall from 250 to 200 percent while the figure for Korean banks will change from 50 to 40 percent.

“A surge in forward trading affects market-based foreign exchanges rates negatively,” a ministry official said. “The slashed ceiling is important at the present stage in terms of securing soundness in macro-economy.”

The policy has come after the BOK and the Financial Supervisory Service reported the market conditions to the Finance Ministry.

Since April, the central bank, in coordination with the financial regulator, has been conducting a probe into foreign exchange banks.

Their inspection has been focused on examination of banks’ management of forward exchange positions and offshore non-deliverable forward trading.

An FSS official said banks’ short-term foreign bonds have continued to increase since last December and shot up by more than $5 billion in March alone.

“It is tentatively estimated that the growth in foreign bonds in the first quarter surpassed $10 billion,” he said. “Such rapid growth needs to be observed, because it can serve as a risky factor that can undermine the stability of the country’s financial market.”

According to the authorities, the sudden surge in short-term external debt is caused by thriving speculations aimed at profiteering from offshore non-deliverable forward trading and the rise in forward exchanges due to the sudden inflow of orders to domestic shipbuilders.

Furthermore, the strong won is inviting more “hot money,” which may spread the volatility to the foreign exchange market.

After tentatively ending the initial probe on May 6, the authorities have restarted their joint probe in mid-May as part of their moves to assess the causes of surge in foreign bonds and devise countermeasures.

The banking sector had already undergone a similar experience on the eve of the global financial crisis, when the nation’s short-term debt ― which had expanded to $134 billion by the end of 2007 ― flushed out during the 2008 global financial crisis, causing a dollar liquidity problem in Korea.

By Kim Yon-se (kys@heraldcorp.com)