Cho, Yoon-Je, and Joon-Kyung Kim (1995), “Credit Policies and the Industrialization of Korea,” World Bank Discussion Paper, No. 286.
Cho, Yoon-Je, and T. Hellmann (1994), “The Government’s Role in Japanese and Korean Credit Markets: A New Institutional Economic Perspective,” Seoul Journal of Economics, Vol. 7, pp. 383–415.
Frankel, J. A. (1993), “Foreign Exchange Policy, Monetary Policy and Capital Market Liberalization in Korea,” in Korean - U.S. Financial Issues, Academic Studies Series, Joint Korea - U.S. Academic Symposium, Vol. 3, New York.
Johnston, R. B. (1994), “The Speed of Financial Sector Reform: Risks and Strategies,” IMF Paper on Policy Analysis and Assessment, PPAA/94/26.
Jwa, Sung-Hee (ed.) (1993), Monetary and Financial Policy Reforms: European Experiences and Alternatives for Korea, Papers and Discussions from a Joint KDI/FES Conference, Seoul.
Nam, Sang-Woo, and Dong-Won Kim (1993), “The Principal Transactions Bank System in Korea and Its Comparison with the Japanese Main Bank System,” Korea Development Institute, Working Paper No. 9312.
Park, Yung Chul (1994), “Korea: Development and Structural Change of the Financial System,” in H. T. Patrick and Yung Chul Park (eds.), The Financial Development of Japan, Korea, and Taiwan, Growth, Repression, and Liberalization, New York.
Shin, Yoonsoo (1995), “The Policy Direction for Korea’s Liberalization of Foreign Exchange and Capital Transactions,” Ministry of Finance and Economy and Korea Development Institute, Economic Bulletin, pp. 20–27.
Tseng, W., and R. Corker (1991), “Financial Liberalization, Money Demand, and Monetary Policy in Asian Countries,” IMF Occasional Paper No. 84.
Prepared by Harald Hirschhofer with assistance from Eduardo Borensztein and Marianne Schulze-Ghattas.
These include deposit money banks, such as the Korea Housing Bank, as well as nonbank financial institutions, such as the Korea Development Bank. See section 3 for a more detailed description of policy-based lending.
Such requirements stipulate, for example, that banks must allocate a certain share of their loan portfolios to certain types of borrowers, such as small- and medium-size enterprises. See section 3 for a more detailed description of the system.
The establishment of foreign bank branches in Korea dates back to the late 1970s. Their treatment has combined both discriminatory as well as preferential elements.
The blueprint reflects the results of financial policy talks between the Korean and the U.S. governments and contains a set of specific measures as well as a detailed implementation schedule. The revised five year economic development plan provides a broader and more general outline of the government’s reform agenda. The main elements of both plans are summarized in tabular form in the annex to “Korea - Recent Economic Developments” (SM/94/28, 1/31/94).
The special banks include the Industrial Bank of Korea, which mainly lends to small- and medium-size enterprises; the Korea Housing Bank, which finances housing construction; and credit cooperatives for agriculture, forestry, and fisheries. The government is the largest shareholder in these institutions.
These institutions include the Korea Development Bank, the Export Import Bank, and the Korea Long-Term Credit Bank. They are part of the nonbank financial sector. The Government is the main shareholder, with the exception of the Korea Long-Term Credit Bank, which was recently privatized. The Korea Development Bank has focussed on long-term loans for special projects, including infrastructure. The Export Import Bank has extended medium- to long-term export financing, mainly for capital goods such as industrial plants and ships. It also underwrites export insurance for domestic corporations and financial institutions. The Korea Long-Term credit bank has focussed on lending to industry.
According to Cho and Kim (1995), the differential between interest rates for general bank loans and preferential loans for export financing narrowed from an average of more than 8 percentage points during 1975-80 to less than 2 percentage points during 1981-91.
Under the new system, the Monetary Board determines the ceiling on the aggregate rediscount volume on a quarterly basis consistent with the annual M2 target. The BOK allocates the available volume among DMBs based on their lending volume.
The Industrial Bank of Korea and Kookmin Bank manage the fund. They will raise W 1 trillion, partly through bond issues, with the government contributing the remaining W 250 billion by selling small business development bonds. Firms raising funds abroad through international bond issues are expected to invest 20 percent in these bonds, or, alternatively, they will only receive permission to raise 80 percent of the intended issue volume.
The Korea Development Bank, the Korea Credit Guarantee Fund, and the Korea Technology Credit Guarantee Fund were authorized to issue credit guarantees of up to W 300 billion, which will be backed by fiscal funds and a newly established “Infrastructure Credit Guarantee Fund.”
Coverage of the system was extended from domestic commercial banks to foreign bank branches and nonbank financial institutions, and mandatory lending ratios were raised.
In addition, nationwide commercial banks are required to allocate at least 50 percent of their new loans to the manufacturing sector.
Foreign bank branches that use the BOK’s rediscount facility are required to set aside 35 percent of their loans for SMEs.
With large enterprises resorting increasingly to capital market financing, many Korean commercial banks have begun to focus on SME lending, and, consequently, the SME lending requirements have become less constraining.
While in the 1970s all business groups whose bank credit exceeded a certain amount were subject to credit controls, the coverage of the system was steadily reduced in the 1980s from 161 business groups in 1984 to the 50 largest groups in 1988. For a detailed description of the system see Nam and Kim (1993).
In addition to limits on total lending to the 30 largest conglomerates, there are separate limits on lending to the 5 largest business groups. In 1991, these limits were 10.81 percent and 5.8 percent, respectively, of a bank’s loan portfolio. However, loans to a group’s core companies, as well as loans to companies with a highly dispersed ownership have been exempted from these limits. Also, basket controls do not apply to nonbank financial institutions. See Nam and Kim (1993).
Each business group subject to the credit control system has a principal transactions bank which is responsible for implementing the various regulations of the system. The process of selecting a principal transactions bank is described in Nam and Kim (1993).
The effectiveness of these controls was, however, undermined to some extent by business practices such as compensating balances or bundling of financial services, which raised the effective cost of credit.
Issue rates of non-guaranteed and guaranteed corporate bonds were first liberalized in 1984 and 1986, respectively. However, controls were subsequently reintroduced. The issue rates of corporate bonds were liberalized again in 1991 (for bonds with maturities exceeding two years) and in 1993 (for bonds with maturities of less than two years).
Commercial bills that are eligible for BOK rediscount remained subject to controls.
The apparent stickiness of nominal deposit rates may be partly due to the fact that published rates correspond to “posted” rates, while large customers tend to negotiate higher interest rates for their deposits. Similarly, published lending rates, which are presented in terms of a relatively wide range, may not adequately reflect actual lending rates. Furthermore, the stability of published deposit and lending rates may be due to nonprice competition for deposits and the continuation of practices such as compensating balances or product bundling in the lending business.
As of July 1995, issue limits for CDs were 150 percent of net worth for commercial banks, and the higher of 400 percent of net worth or W 25 billion for foreign banks. The shortest permissible maturity was 30 days, and the minimum denomination was W 20 million.
The committee proposes a candidate who, if accepted by the Office of Bank Supervision, is endorsed by the general meeting of stockholders. The committee consists of three ex-president of the bank, two large stockholders, two small stockholders, one representative of corporate clients, and one representative of general customers. The largest five conglomerates are excluded from representation on the nomination committee.
In July 1995, nationwide banks were granted permission to open without prior approval up to 15 new branches in 1996, 23 in 1997, and 30 in 1998 provided that they meet several conditions, including a capital adequacy ratio of 8 percent.
Commercial banks may currently pay up to 60 percent of their after tax net profits as dividends without prior approval by the Office of Banking Supervision if their loan loss reserves fully cover the weighted non-performing loans and the ratio of weighted bad loans is less than 2 percent, or if they receive management performance ratings of A in three consecutive years. Weighted non-performing loans include questionable loans, loan losses, and 20 percent of collateralized loans with interest payments overdue for more than three months. If loan loss reserves amount to more than 80 percent of weighted non-performing loans, banks are allowed to pay 50 percent of their net income as dividends. Banks which do not meet this requirement are allowed to pay dividends of up to 40 percent of net income.
The three groups would be separated but business involvement across borders would be allowed through subsidiaries.
Deposit money banks have been allowed to organize the issue and retail distribution of public sector bonds.
Capital requirements were eased, the requirement to operate a representative office for more than two years prior to opening a branch office was dropped, the opening of more than one branch office was allowed. Foreign securities firms which have a good track record of more than two years have also been allowed to issue and trade CDs.
Experiences in other countries suggest that financial sector liberalization and the ensuing higher levels of competition may lead to moral hazard and increase the systemic risk. A high burden of existing bad debt in the portfolios of financial intermediaries paired with low capitalization is likely to aggravate these problems. See Johnston (1994), and Galbis (1994).
CAMEL stands for: capital adequacy, asset quality, management ability, earnings quality, and liquidity level.
Currently deposit insurance is available only for NBFI deposits.
According to a recently introduced government bill, each depositor would be insured for up to W 20 million. This would cover 97 percent of all depositors at domestic banks. The proposed insurance would protect won-denominated demand and savings deposits, and specific money trust accounts at domestic and foreign banks. Risk premia would eventually be differentiated according to business performance.
Prior to this change, banks were permitted to build up loan loss reserves equivalent to two percent of total loans.
The sum of loss-risk weighted loans consists of 20 percent of substandard loans and 100 percent of doubtful and estimated loss loans.
In the first half of 1995, bad loans increased to W 2.7 trillion or 1.2 percent of total loans due to technical re-classifications and several bankruptcies.
Foreign investors were granted indirect access to the domestic securities market through international trust funds, and Korean firms were allowed to issue, subject to limits, convertible bonds, bonds with warrants, and depository receipts in international financial markets. At the same time, an increasing number of sectors were opened up for foreign direct investment.
Korean securities companies were permitted to participate in syndicated underwriting of foreign securities, and insurance and investment trust companies were allowed to invest, subject to certain limits, in foreign securities.
In January 1992, foreign investors were granted direct access to the domestic stock market subject to certain limits. Initially, a 10 percent limit applied to the share of total foreign investment in a company’s stocks. This ceiling has since been raised twice, to 12 percent in December 1994, and to 15 percent in July 1995. The 3 percent cap on the share of a company’s stocks held by a single foreign investor has so far remained unchanged.
In addition, in mid 1994, the Government presented a plan for the improvement of the environment for foreign direct investment
This strategy is based on the presumption that given the large interest differential in favor of Korean assets, the opening of the capital account will lead to substantial net inflows of capital.
Figures are based on the 1994 Reform Plan for the Improvement in the Foreign Investment Environment.
Explicit approval is still required in exceptional cases.
In addition, the tax treatment of FDI companies has been improved and measures to ameliorate labor management relations are planned.
As of July 1995, outward direct investment by Korean companies exceeding $30 million was subject to approval, investments of $0.3-30 million were subject to notification.
The 3 percent limit of individual foreign ownership has so far been retained and the reform plan does not specify any changes in the limit.
Foreign investment in public bonds is limited to the primary market for bonds whose interest rates are close to international rates. Foreign investment in bonds issued by SMEs is restricted to convertible, non-guaranteed bonds and subject to a 30 percent limit on total foreign investment per issue and a 5 percent limit on individual investors.
Foreign investment would remain restricted to non-guaranteed bonds.
Foreign as well as domestic residents would be allowed to issue such bonds.
Overseas holdings of foreign currency have so far been restricted to foreign business activities. Prior to 1993, only general trading companies were permitted to hold foreign currency overseas. In 1993, the permission was extended to other companies within certain limits, provided their external transactions exceed a certain minimum amount. Both, the limits and the eligibility criteria have since been eased but not abolished. Individuals are allowed to hold, within relatively narrow limits, foreign claims overseas without remitting them to Korea.
Defined as lending for the purpose of asset management.
Lending for the purpose of asset management would remain subject to ceilings even for institutional investors.
The category “commercial loans” covers foreign borrowing in excess of $1 million and with a maturity of more than 3 years for the purpose of capital goods imports or the repayment of other foreign debt.
Korean firms have had access to foreign currency loans through domestic financial institutions, which have been allowed to borrow abroad and onlend these funds. Such borrowing has, however, been subject to government controls.
Earlier this year, foreign-invested companies in the manufacturing sector were allowed to borrow directly abroad. The limits on such borrowing are higher for high-tech related activities than for other activities.
Currently only foreign exchange banks are free to offer or accept guarantees and collateral. Companies (financial as well as nonfinancial) and private individuals need approval. It is planned to gradually reduce this requirement within certain limits.
This ceiling is defined as a percentage of the previous year’s export value.
This implies that all foreign exchange transactions must be related to a current account transaction or a permitted capital account transaction, even though documentation verifying the underlying transaction is no longer required.
Until 1993, the position limits were defined in relation to a bank’s average balance of foreign exchange bought in the preceding month. During a two year transition period (1993-95) banks were permitted to chose between the average balance and the net worth concept.