By the end of 2025, South Korea’s financial markets offered a paradox. Prices moved sharply, yet the system did not break. Equity indices surged, bond yields rose and the won weakened — but none of this tipped into crisis. Beneath the surface, however, the numbers tell a more uneasy story: stability was preserved, but vulnerabilities quietly accumulated.
The Bank of Korea’s semiannual Financial Stability Reports capture this duality well. The Financial Stress Index stood at 15.0 in November, down from 18.6 in June — safely below crisis territory. But the Financial Vulnerability Index climbed to 45.4 in the third quarter, closing in on its long-term average of 45.7. Stability improved at the margin; structural fragilities did not.
Equities: a rally powered by policy and narrative
The stock market’s performance was striking. The KOSPI rose from around 2,399 in early June to 4,144 by December 9, ending the year just below that level at 4,129.7. Few developed markets posted a comparable surge in such a short period.
The first-half rally had clear drivers: expectations of capital-market reform, enthusiasm around artificial intelligence, and anticipation of supplementary fiscal stimulus.
The second half of the year told a more complicated story. Trade tensions, policy uncertainty and profit-taking amplified volatility, while November brought renewed debate over whether AI valuations had run ahead of fundamentals. Yet prices continued to push higher. The rally was sustained less by earnings than by narrative — a familiar pattern in late-cycle markets.
This distinction matters for 2026. Upside may remain, but direction will be less important than volatility. If AI earnings disappoint or valuation concerns resurface, corrections could be abrupt rather than gradual.
Bonds: higher yields, but no credit stress
Government bond yields rose through the year, with the three-year Korean Treasury yield ending around 3.1 percent. On its own, that would normally signal tighter financial conditions. But credit markets told a different story.
Corporate bond spreads remained close to long-term averages. AA-rated spreads hovered near 55 basis points, while A-rated spreads stayed around 150 basis points. Even in November, when rising government yields and heavier bank bond issuance pushed spreads modestly wider, there was no sign of systemic strain.
This resilience is central to the BOK’s assessment that the financial system remains broadly stable. Prices moved sharply; credit transmission did not fracture.
Foreigners versus residents: the real story lies at home
Looking only at foreign flows would give a misleading picture. In the first half of 2025, foreigners sold about $10.6 billion of Korean equities while buying roughly $25 billion in bonds. By year-end, their equity ownership ratio had actually risen to 32 percent, and their share of bond holdings to 12.1 percent. Net foreign inflows into bonds for the year reached roughly $47 billion.
The more consequential shift came from Korean residents themselves.
Between January and October, residents invested $117.1billion net in overseas securities — including $89.9 billion in equities and $27.2 billion in bonds. October alone recorded a record $17.3 billion outflow. This was not short-term currency speculation but a structural reallocation of portfolios.
In effect, Korean households and institutions increasingly chose to place marginal savings abroad rather than at home. That shift matters more for market dynamics than foreign positioning.
FX: a high plateau becomes the norm
The won’s trajectory in 2025 reflects this structural change. From around 1,350 per dollar in June, it weakened into the 1,470s by October and November, reaching 1,472 on December 9. Toward year-end, verbal intervention and hedging flows helped stabilize the rate near 1,440. On annual basis, the dollar would have averaged 1,421.9 won, set for a record. The past average high for the pair was 1,394.9 won in 1998 amid IMF bailout.
The central bank attributed to “large fluctuations” rather than crisis conditions, noting that external funding conditions remain sound. But the level itself is telling. The exchange rate has moved onto a higher plateau. Trade balances alone no longer anchor the won. Capital flows do — particularly outbound portfolio investment by residents. In that sense, the exchange rate in 2025 was shaped less by exports than by asset allocation.
Valuation gaps and the logic of capital flight
One reason behind the surge in overseas investment is the valuation gap between US and Korean equities.
In 2025, the S&P 500 traded at roughly 20 times earnings, with the Nasdaq even higher. Korea’s market, by contrast, has long hovered in the high single digits to low teens. This is not simply a question of “cheap versus expensive”. It reflects expectations of earnings durability.
The U.S. markets are anchored by AI, platform businesses and intellectual-property-intensive sectors, supported by shareholder-friendly governance and deep capital markets. Korea, by contrast, still carries a structural discount tied to earnings volatility, governance concerns and policy uncertainty.
As a result, new investment increasingly bypasses the domestic market altogether. Rather than selling Korean shares to buy US ones, investors often send fresh capital abroad from the outset. The Bank of Korea itself notes that resident overseas investment is increasingly long-term and strategic in nature.
Household credit: mortgages cool, other loans reawaken
Household debt dynamics underline the same shift. Mortgage growth slowed markedly in 2025. Outstanding housing loans reached 1,159.6 trillion won by the third quarter, up 4.3 percent year on year — a deceleration from earlier periods.
But other forms of credit told a different story. “Other loans” rose to 685.4 trillion won, turning positive year on year for the first time in some time. Monthly increases reached 4.9 trillion won in October and 4.1 trillion won in November. The central bank explicitly links this rebound to demand for equity investment.
In other words, leverage did not disappear; it changed channels. As mortgage lending was restrained, borrowing increasingly supported financial investment — including overseas exposure — with implications for both asset prices and the exchange rate.
The policy challenge for 2026: structure, not rates
The lesson of 2025 is not primarily about whether interest rates should fall or stay put. Marke data point to a deeper issue.
Financial stress is contained, but vulnerabilities are rebuilding. The FVI stands at 45.4. Housing prices in Seoul are accelerating again. Non-mortgage lending is reviving. Overseas investment continues to surge. These are not crisis signals — but they are early warnings.
The success or failure of policy in 2026 will hinge less on the direction of rates than on whether imbalances are allowed to compound.
Three questions matter most: Can authorities contain renewed overheating in Seoul’s housing market? Can leverage flowing into equities and derivatives be monitored without choking markets? Can surging overseas investment be absorbed without destabilizing the exchange rate?
2025 was a year of prices.
2026 will be a test of structure.
* The author is the managing editor of AJP.
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