Abstract
This Background Paper provides a broad overview of the structure and characteristics of public finances in Korea, and discusses fiscal policy against the background of the medium-term objectives. The analysis shows that despite constraints imposed by the institutional framework, the government has managed to maintain tight budgetary control. The paper analyzes trends in the size and composition of central government expenditure, revenue, financing, and debt. It also evaluates the stance of fiscal policy on the basis of summary indicators.
III. Financial Sector Reform and External Capital Account Opening 1/
1. Introduction
Financial institutions in Korea have traditionally played a key role as a vehicle of industrial policy based on preferential financing. This policy spawned a host of government regulations and interventions, which hampered the development of an efficient and competitive financial sector. In the 1980s the drawbacks of the system became increasingly evident, giving rise to a series of selective liberalization measures. However, given the limited scope of these measures, financial sector development continued to lag behind the rest of the economy, prompting efforts to broaden and deepen the reform process. In the early 1990s, financial sector deregulation and capital account opening thus became top priorities for structural policies, and in 1993 a comprehensive, multi-year reform plan was presented.
This chapter reviews the process of financial sector liberalization and capital account opening in Korea. Section 2 provides a brief overview of the evolution of financial sector reform since the early 1980s, while sections 3 and 4 focus on the main elements of the current reform program. Section 3 reviews reforms in the domestic financial sector, and section 4 discusses capital account liberalization and exchange reform. Section 5 summarizes the findings.
2. Financial sector reform since the early 1980s: an overview
In the 1960s and particularly in the 1970s, the main objective of financial sector policies was to channel credit at preferential interest rates to targeted sectors. The Government influenced the sectoral allocation of credit through direct government control over commercial and specialized banks, which at the time were state-owned, the Bank of Korea’s (BOK’s) rediscount facility, and control over foreign borrowing. Interest rates were regulated, financial innovation was restricted, and entry barriers were high to limit competition. Nevertheless, in order to absorb the sizable informal credit market, the Government in the 1970s permitted the establishment of new, less regulated and privately-owned financial institutions. These institutions quickly developed into a thriving nonbank financial sector, whose share in total deposits rose from 21 percent in 1975 to 71 percent in 1994. 2/
In the late 1970s, the costs of extensive policy-based lending—inefficiencies in credit allocation and inadequate monetary control—became increasingly evident and prompted a move toward partial liberalization. 3/ In the 1980s, commercial banks were privatized (1981-83), several new banks were allowed to enter the market, and restrictions on the business activities of bank and nonbank financial institutions were eased. While the Government continued to influence credit allocation through rediscount policy, the lending policies of government-owned special banks, 1/ and special lending requirements, 2/ the degree and scope of such interventions were scaled back.
In order to further the development of financial markets, a number of new financial instruments, such as repurchase agreements (RPs), certificates of deposit (CDs), and commercial paper (CPs) were permitted, and interest rates for some money and bond market instruments were liberalized in the 1980s. A more comprehensive plan for interest rate deregulation, which envisaged the liberalization of most lending and long-term deposit rates, was, however, effectively revoked shortly after its introduction in late 1988 because of a sharp rise in market-determined interest rates.
The partial reforms in the domestic financial sector were accompanied by selective measures to open it up to foreign competition and to ease restrictions on international capital movements. Indirect foreign investment in the Korean stock market through special investment funds and foreign portfolio investment by Korean institutional investors was permitted on a limited scale, regulations concerning foreign direct investment were relaxed, and restrictions on the operations of foreign banks were eased. 3/ In addition, foreign life insurance companies and, on a limited scale, foreign securities firms were granted access to the domestic market.
In the early 1990s, selective measures continued while preparations for a more comprehensive reform program began. In 1991, a four-stage schedule for the complete liberalization of interest rates was announced, which was subsequently included in a comprehensive, five-year plan (blueprint) for financial sector liberalization and capital account opening. This plan was presented in 1993 and describes the core of the financial sector reform program. In addition, the Government’s revised medium-term economic development plan (Five-Year Plan for the New Economy) outlines in broad terms a number of supporting reforms in the structure of the financial system. 1/ Subsequently, in late 1994, the five-year Foreign Exchange Reform Plan was presented, which broadens the scope of the external part of the 1993 reform plan.
The overriding objective of the reform program is to enhance the efficiency of the financial sector by reducing government intervention and facilitating greater integration into international financial markets. The program focuses on the following areas: reform of policy loans, mandatory lending requirements, and credit controls; deregulation of interest rates and financial instruments; reform of monetary policy instruments; and liberalization of foreign exchange and capital account transactions. The implementation schedule is gradual to give financial institutions time to adapt to a more competitive environment. In addition, the program includes supporting reforms to strengthen the competitiveness of financial institutions as well as bank supervision to safeguard the soundness of the financial system.
3. Reform of the domestic financial sector
This section focusses on the main elements of the reform agenda for the domestic financial sector: the reform of policy loans, special lending requirements, and credit controls; and the deregulation of interest rates and financial instruments (Table III.1). It also covers reforms in regulations concerning bank management, financial institutions’ business activities, and the supervisory framework. It excludes issues relating to the reform of the monetary policy framework, which are discussed in chapter IV.
Korea: Domestic Financial Sector Liberalization—Schedule and Implementation of Selected Measures 1/
The measures are presented according to the original implementation schedule; dates in parentheses indicate month and year of implementation, which, in some cases, was ahead of schedule.
Korea: Domestic Financial Sector Liberalization—Schedule and Implementation of Selected Measures 1/
| Deregulation of Interest Rates | Deregulation of Financial Instruments | Credit Control System and Lending Guidelines | |
|---|---|---|---|
| Phase 1 (1993) | Deregulation of interest rates on:
| Auction sales of MSBs and treasury bonds (3/93). | Simplification of credit control criteria and procedures for large corporations (2/93). Increasing transparency of regulations governing mandatory lending to small- and medium-size enterprises (SMEs) (3/93). |
| Phase 2 (1994-95) | Deregulation of interest rates on loans that are eligible for BOK rediscounting (including commercial bills) (7/95). | Diversification of short-term instruments (ongoing). Easing of restrictions on short-term financial instruments (maturities and issue limits) (ongoing). | Prior approval for investment in new businesses and real estate by large conglomerates to be waived (5/95); Revision of laws relating to credit control system for large conglomerates (Fair Trade Act, Industrial Development Act, tax laws). Reduction of policy loans to SMEs; transfer of such loans to government sector (ongoing). Expansion of credit guarantees for SMEs to enhance their access to credit markets (ongoing). |
| Phase 3 (1996-97) | 1996: Deregulation of interest rates on:
| Authorization of new short-term products, including money market certificates and money market funds. | Credit controls for large conglomerates to be limited to overall ceiling for each conglomerate to ensure sound banking practices. Gradual phasing out of mandatory lending to SMEs. Expansion of market-based lending to SMEs through improved accounting practices and better loan screening techniques. |
| 1997: Preparation of plan for phased deregulation of interest rates on demand deposits. | 1997: Study on abolishing restrictions on short-term instruments. |
The measures are presented according to the original implementation schedule; dates in parentheses indicate month and year of implementation, which, in some cases, was ahead of schedule.
Korea: Domestic Financial Sector Liberalization—Schedule and Implementation of Selected Measures 1/
| Deregulation of Interest Rates | Deregulation of Financial Instruments | Credit Control System and Lending Guidelines | |
|---|---|---|---|
| Phase 1 (1993) | Deregulation of interest rates on:
| Auction sales of MSBs and treasury bonds (3/93). | Simplification of credit control criteria and procedures for large corporations (2/93). Increasing transparency of regulations governing mandatory lending to small- and medium-size enterprises (SMEs) (3/93). |
| Phase 2 (1994-95) | Deregulation of interest rates on loans that are eligible for BOK rediscounting (including commercial bills) (7/95). | Diversification of short-term instruments (ongoing). Easing of restrictions on short-term financial instruments (maturities and issue limits) (ongoing). | Prior approval for investment in new businesses and real estate by large conglomerates to be waived (5/95); Revision of laws relating to credit control system for large conglomerates (Fair Trade Act, Industrial Development Act, tax laws). Reduction of policy loans to SMEs; transfer of such loans to government sector (ongoing). Expansion of credit guarantees for SMEs to enhance their access to credit markets (ongoing). |
| Phase 3 (1996-97) | 1996: Deregulation of interest rates on:
| Authorization of new short-term products, including money market certificates and money market funds. | Credit controls for large conglomerates to be limited to overall ceiling for each conglomerate to ensure sound banking practices. Gradual phasing out of mandatory lending to SMEs. Expansion of market-based lending to SMEs through improved accounting practices and better loan screening techniques. |
| 1997: Preparation of plan for phased deregulation of interest rates on demand deposits. | 1997: Study on abolishing restrictions on short-term instruments. |
The measures are presented according to the original implementation schedule; dates in parentheses indicate month and year of implementation, which, in some cases, was ahead of schedule.
a. Policy loans, mandatory lending ratios, and credit controls
The Korean Government has traditionally used three instruments to influence credit allocation: policy loans, mandatory lending ratios, and credit controls. While these instruments differ significantly in their nature and rationale, their ultimate purpose is to direct the distribution of credit among different types of borrowers and projects.
(i) Policy loans
Policy loans can be defined as loans that are either directly (through government control of the lending institution) or indirectly (through government or central bank financial support) influenced by government policy. 1/ Based on this definition, which covers the lending activities of government-owned special banks 2/ and development institutions 3/ as well as a substantial share of commercial bank credit, policy loans accounted for 21 percent of total private sector credit in 1994, compared with 37 percent in 1980 (Table III.2). While direct financial assistance from the budget has been small, central bank refinancing has played a key role in supporting policy-based lending, with loans refinanced by the Bank of Korea (BOK) accounting for more than a quarter of the policy loans extended by deposit money banks (DMBs) during 1987-91. 4/ As a result, rediscount policy in Korea has traditionally been a tool of industrial policy and its role as a monetary control instrument has been limited.
Korea: Policy-Based Lending, 1980-94 1/
The definition of policy-based lending used in this table follows the concept adopted in OECD (1994).
Includes loans extended by the Industrial Bank of Korea, the Korea Development Bank, the EXIM Bank, the Long-term Credit Bank, as well as loans and discounts of the Bank of Korea.
Includes loans extended by the Korea Housing Bank and Credit Cooperatives for Agriculture, Forestry, and Fisheries.
Borrowing from government funds by financial institutions listed in footnotes 2 and 3, except the Bank of Korea.
Korea: Policy-Based Lending, 1980-94 1/
| 1980 | 1985 | 1990 | 1991 | 1992 | 1993 | 1994 | ||
|---|---|---|---|---|---|---|---|---|
| (In billions of won) | ||||||||
| Industrial loans 2/ | 7,302 | 23,592 | 36,690 | 44,060 | 51,076 | 56,329 | 60,458 | |
| Other sectoral loans 3/ | 2,178 | 6,013 | 16,810 | 20,086 | 24,092 | 28,667 | 33,030 | |
| Total | 9,480 | 29,605 | 53,500 | 64,146 | 75,168 | 84,996 | 93,489 | |
| (In percent of private sector credit) | ||||||||
| Industrial loans | 28.8 | 30.7 | 18.1 | 17.4 | 17.1 | 16.0 | 13.6 | |
| Other sectoral loans | 8.6 | 7.8 | 8.3 | 7.9 | 8.0 | 8.1 | 7.4 | |
| Total | 37.3 | 38.6 | 26.3 | 25.3 | 25.1 | 24.1 | 21.1 | |
| Memorandum item: | ||||||||
| Borrowing from government funds 4/ | 1.2 | 5.7 | 3.0 | 2.7 | 2.6 | 2.5 | 2.3 | |
The definition of policy-based lending used in this table follows the concept adopted in OECD (1994).
Includes loans extended by the Industrial Bank of Korea, the Korea Development Bank, the EXIM Bank, the Long-term Credit Bank, as well as loans and discounts of the Bank of Korea.
Includes loans extended by the Korea Housing Bank and Credit Cooperatives for Agriculture, Forestry, and Fisheries.
Borrowing from government funds by financial institutions listed in footnotes 2 and 3, except the Bank of Korea.
Korea: Policy-Based Lending, 1980-94 1/
| 1980 | 1985 | 1990 | 1991 | 1992 | 1993 | 1994 | ||
|---|---|---|---|---|---|---|---|---|
| (In billions of won) | ||||||||
| Industrial loans 2/ | 7,302 | 23,592 | 36,690 | 44,060 | 51,076 | 56,329 | 60,458 | |
| Other sectoral loans 3/ | 2,178 | 6,013 | 16,810 | 20,086 | 24,092 | 28,667 | 33,030 | |
| Total | 9,480 | 29,605 | 53,500 | 64,146 | 75,168 | 84,996 | 93,489 | |
| (In percent of private sector credit) | ||||||||
| Industrial loans | 28.8 | 30.7 | 18.1 | 17.4 | 17.1 | 16.0 | 13.6 | |
| Other sectoral loans | 8.6 | 7.8 | 8.3 | 7.9 | 8.0 | 8.1 | 7.4 | |
| Total | 37.3 | 38.6 | 26.3 | 25.3 | 25.1 | 24.1 | 21.1 | |
| Memorandum item: | ||||||||
| Borrowing from government funds 4/ | 1.2 | 5.7 | 3.0 | 2.7 | 2.6 | 2.5 | 2.3 | |
The definition of policy-based lending used in this table follows the concept adopted in OECD (1994).
Includes loans extended by the Industrial Bank of Korea, the Korea Development Bank, the EXIM Bank, the Long-term Credit Bank, as well as loans and discounts of the Bank of Korea.
Includes loans extended by the Korea Housing Bank and Credit Cooperatives for Agriculture, Forestry, and Fisheries.
Borrowing from government funds by financial institutions listed in footnotes 2 and 3, except the Bank of Korea.
As noted above, government intervention in the financial sector through policy-based lending was reduced substantially in the 1980s. The relative size of policy loans in relation to total private credit declined, and the differential between lending rates for general bank loans and policy loans was narrowed significantly. 5/ In addition, the focus of policy-based lending shifted from targeting specific industries toward functional support for activities such as exports and investment in R&D, and support for small-and medium-size enterprises, which previously had benefitted little from the system. However, notwithstanding the reduction in the implicit subsidization of policy loans, they continued to play an important role by ensuring availability of financing in a system characterized by widespread non-price rationing due to interest rate controls.
The Government’s plan for financial sector liberalization does not envisage a complete elimination of policy-based lending. It is planned, however, to further reduce its relative size in relation to total private credit, and to phase out the involvement of commercial banks and the Bank of Korea by shifting policy loans entirely to special, government-owned financial institutions with financial support provided by government funds.
The reform plan does not contain a precise schedule indicating when this shift would be completed. Nevertheless, as a first step, an aggregate ceiling on BOK rediscounts of foreign trade and commercial bills was introduced in March 1994, which ended the quasi-automatic rediscounting of such bills. 1/ Following the introduction of the ceiling system, the overall volume of BOK loans and discounts decreased from W 16 trillion in 1993 to W 13.5 trillion in 1994. In 1995, in order to cushion the impact on small- and medium-size enterprises (SMEs), a special fund was established to provide rediscounts for SME commercial bills. 2/ Furthermore, in line with the planned shift in the funding for policy-based lending, fiscal contributions to loan guarantee funds were raised from W 150 billion in 1993 to W 310 billion in 1994. 3/
(ii) Mandatory lending ratios
Mandatory lending ratios stipulate that financial institutions set aside a certain share of new loans for SMEs to ensure adequate financing for these enterprises. Formally introduced in the mid-1970s, these regulations were expanded 1/ and more strictly enforced in the 1980s as disparities in access to financing between large conglomerates (which had been the main beneficiaries of extensive policy-based lending in the 1970s) and SMEs became a cause for concern. Mandatory lending ratios vary by type of financial institution. In 1992, nationwide commercial banks were required to allocate 45 percent, 2/ local banks 80 percent, and branches of foreign banks 25 percent of their lending to SMEs. 3/
Consistent with the objective of reducing government intervention in the operations of financial institutions, the financial sector reform program envisages a phasing out of mandatory lending ratios by the end of 1997, but a specific time has not been set. While the mandatory lending ratio for local banks was reduced from 80 to 70 percent in 1994, the corresponding ratios for nationwide commercial banks and branches of foreign banks have, so far, remained unchanged. 4/
(iii) Credit controls
As a complement to the system of mandatory lending ratios for SMEs, lending to large business groups has been subject to various forms of controls. Introduced in the mid-1970s to reduce companies’ leverage and encourage stock market financing, such controls have been used since the mid-1980s mainly to prevent heavy concentration of credit and limit the expansion of large conglomerates through new acquisitions and real estate investment. 5/ In the late 1980s and early 1990s, the credit control system has focused on restricting credit to the 30 largest conglomerates through so-called basket provisions, which limit the share of lending to these business groups in a bank’s total, loan portfolio, 1/ and on controlling their investments in new businesses. In addition, real estate investments of the largest 50 conglomerates have been subject to controls. The system has been administered by banks under the guidance of the Office of Bank Supervision and Examination. 2/
As outlined in the Government’s plan for financial sector liberalization, the number of business groups that have to obtain approval for investment in real estate and new businesses has been reduced steadily in the past two years, and since May 1995 all conglomerates have been exempted. While the basket credit controls for the 30 largest conglomerates still apply, it is planned to phase out aggregate ceilings during 1996-97 and to replace them by prudential regulations limiting bank exposure to individual business groups.
b. Deregulation of interest rates and financial instruments
Interest rate controls have been extensive and affected in the past more or less all types of financial instruments. Controls on lending rates sought to keep financing costs low, 3/ while ceilings on deposit rates ensured a sufficient profit margin for financial institutions. The regulation of deposit rates at low levels necessitated in turn tight controls over other financial instruments so as to limit portfolio shifts away from deposits. Banks as well as nonbank financial institutions (NBFIs) have been subject to interest rate controls, but the latter have generally been allowed to offer higher deposit rates and charge higher lending rates than banks.
Selective measures during the 1980s focused on the liberalization of interest rates on money and bond market instruments such as commercial paper, call money, financial debentures, as well as guaranteed and unguaranteed corporate bonds. 1/ In addition, new instruments such as CDs, RPs, cash management accounts, and bankers’ acceptances were introduced. Nevertheless, many of these instruments, notably CDs, remained subject to restrictions on maturities, minimum denominations, and issues volumes. Even though a number of short-term bank lending rates (overdrafts, commercial bills, 2/ and trade bills) and long-term deposit rates (deposits with maturities exceeding three years) were liberalized in 1991, most lending and deposit rates were still subject to controls when the financial sector reform plan was presented in 1993.
The plan envisages the deregulation of all lending and deposit rates, with the exception of interest rates on demand deposits, which will be considered in 1997. In order to limit competitive pressures during the transition to a fully liberalized system, the schedule for the liberalization of lending rates is faster than that for deposit rates, with the deregulation of long-term deposit rates preceding the liberalization of short-term rates. In addition, the plan envisions the introduction of new financial instruments such as money market certificates and funds, and a further easing of restrictions on existing ones.
In line with the plan’s schedule, a substantial part of the measures have been implemented. In November 1993, all lending rates, except those for loans backed by BOK or government funds (policy loans) were deregulated. Subsequently, in July 1995, interest rates on loans that are eligible for BOK refinancing were liberalized, leaving only policy loans supported by government funds, which account for some 5 percent of total loans and discounts by DMBs and NBFIs, subject to controls.
On the deposit side, interest rates on time deposits with maturities of two years or more were deregulated in November 1993, followed in December 1994 (ahead of schedule) by the liberalization of interest rates on time deposits with maturities of one to two years, and of interest rates on installment savings deposits with maturities of over two years. With the deregulation in July 1995 (also ahead of schedule) of interest rates on time deposits with maturities of six months to one year, and on installment savings deposits with maturities of one to two years, interest rates of about 77 percent of all DMB and NBFI deposits were liberalized as of end July 1995. Liberalization of the remaining time and installment savings deposit rates scheduled for implementation by the end of 1996.
Judging from published data, the liberalization measures so far appear to have had little impact on interest rates. Lending and deposit rates have been broadly s, notwithstanding a rise in other market-determined rates since mid-1994 (Table III.3). 1/ There is, however, some indirect evidence that rates of return on deposits may have changed after the liberalization. For example, time deposits with maturities of two years or more, whose interest rates were liberalized in 1993, have expanded rapidly since then, while time deposits with shorter maturities (one to two years) barely grew in 1993-94, picking up only in early 1995 after their interest rates were liberalized (Table III.4). There are also indications that the decontrol of deposit rates may have slowed the steady decline in the market share of commercial banks, which under controlled interest rates were at a disadvantage relative to NBFIs as the latter were allowed to offer higher returns. After declining steadily from 44 percent in 1980 to 18 percent in 1993, the share of commercial banks in total deposits of financial institutions stabilized in 1994.
Korea: Developments in Selected Deposit and Lending Rates, 1990-1995
(In percent)
Twelve-month average percentage change.
Period average.
Korea: Developments in Selected Deposit and Lending Rates, 1990-1995
(In percent)
| Q1 | Q2 | Q3 | Q4 | Q1 1995 | |||||
|---|---|---|---|---|---|---|---|---|---|
| 1991 | 1992 | 1993 | 1994 | ||||||
| Deposit money banks, time deposits, 2-3 years | 12.0 | 12.0 | 10.5~11.5 | 10.5~11.5 | 10.5~11.5 | 10.5~11.5 | 10.5~11.5 | 10.5~11.5 | |
| Deposit money banks, time deposits, 3 years | 13.0 | 13.0 | 11.0~11.5 | 11.0~12.0 | 10.8~11.5 | 10.8~11.5 | 10.9~11.5 | 10.8~12.2 | |
| Nonbank financial institutions, time deposits, 3 years | 14.0 | 14.0 | 12.0~13.5 | 11.5~13.0 | 11.4~13.2 | 10.6~14.3 | 11.7~14.1 | 11.2~13.9 | |
| General loans of commercial banks | 10.0~12.5 | 10.0~12.5 | 8.5~12.0 | 8.5~12.0 | 8.5~12.3 | 8.5~12.5 | 8.5~12.5 | 9.0~12.5 | |
| Overdrafts of commercial banks | 12.0~15.0 | 10.25~14.75 | 9.5~13.0 | 9.5~13.5 | 10.0~13.7 | 10.0~14.0 | 10.0~14.0 | 10.1~17.7 | |
| Loans overdue of commercial banks | 21 | 21 | 17~18 | 17.0~18.0 | 17.0~18.0 | 17.0~18.0 | 17.0~18.0 | 17.0~18.3 | |
| Memorandum items: | |||||||||
| CPI 1/ | 9.3 | 6.2 | 4.8 | 5.5 | 5.8 | 6.3 | 6.4 | 6.2 | |
| Corporate bond yield 2/ | 18.9 | 16.2 | 12.6 | 12.2 | 12.4 | 13.2 | 13.9 | 15.1 | |
| Yield on 91-days CDs 2/ | … | 16.4 | 13.0 | 12.0 | 12.4 | 14.3 | 14.4 | 15.9 | |
Twelve-month average percentage change.
Period average.
Korea: Developments in Selected Deposit and Lending Rates, 1990-1995
(In percent)
| Q1 | Q2 | Q3 | Q4 | Q1 1995 | |||||
|---|---|---|---|---|---|---|---|---|---|
| 1991 | 1992 | 1993 | 1994 | ||||||
| Deposit money banks, time deposits, 2-3 years | 12.0 | 12.0 | 10.5~11.5 | 10.5~11.5 | 10.5~11.5 | 10.5~11.5 | 10.5~11.5 | 10.5~11.5 | |
| Deposit money banks, time deposits, 3 years | 13.0 | 13.0 | 11.0~11.5 | 11.0~12.0 | 10.8~11.5 | 10.8~11.5 | 10.9~11.5 | 10.8~12.2 | |
| Nonbank financial institutions, time deposits, 3 years | 14.0 | 14.0 | 12.0~13.5 | 11.5~13.0 | 11.4~13.2 | 10.6~14.3 | 11.7~14.1 | 11.2~13.9 | |
| General loans of commercial banks | 10.0~12.5 | 10.0~12.5 | 8.5~12.0 | 8.5~12.0 | 8.5~12.3 | 8.5~12.5 | 8.5~12.5 | 9.0~12.5 | |
| Overdrafts of commercial banks | 12.0~15.0 | 10.25~14.75 | 9.5~13.0 | 9.5~13.5 | 10.0~13.7 | 10.0~14.0 | 10.0~14.0 | 10.1~17.7 | |
| Loans overdue of commercial banks | 21 | 21 | 17~18 | 17.0~18.0 | 17.0~18.0 | 17.0~18.0 | 17.0~18.0 | 17.0~18.3 | |
| Memorandum items: | |||||||||
| CPI 1/ | 9.3 | 6.2 | 4.8 | 5.5 | 5.8 | 6.3 | 6.4 | 6.2 | |
| Corporate bond yield 2/ | 18.9 | 16.2 | 12.6 | 12.2 | 12.4 | 13.2 | 13.9 | 15.1 | |
| Yield on 91-days CDs 2/ | … | 16.4 | 13.0 | 12.0 | 12.4 | 14.3 | 14.4 | 15.9 | |
Twelve-month average percentage change.
Period average.
Korea: Growth of Selected Deposits 1/
End of March of respective year relative to end of March of the previous year.
Korea: Growth of Selected Deposits 1/
| 1992 | 1993 | 1994 | 1995 | |||
|---|---|---|---|---|---|---|
| (Percentage change) | ||||||
| Deposit money banks, total deposits | 17.5 | 7.7 | 12.5 | 18.0 | ||
| Demand deposits | 22.4 | -10.4 | 0.2 | 19.0 | ||
| Time & savings deposits | 15.3 | 16.1 | 16.9 | 17.7 | ||
| Time deposits | 7.8 | 3.5 | 12.5 | 24.2 | ||
| Less than one year | -20.0 | -9.4 | 14.8 | 10.0 | ||
| One to two years | 14.3 | 0.4 | 0.3 | 19.6 | ||
| More than two years | 29.1 | 19.0 | 29.7 | 37.0 | ||
| Installment savings deposits | 19.4 | 8.1 | 16.4 | 18.6 | ||
| Mutual installments | 8.0 | 0.5 | 19.5 | 22.2 | ||
| Housing installments | 43.8 | 39.2 | 41.7 | 25.8 | ||
| Workman’s property formation | -9.1 | 0.6 | -10.4 | -15.8 | ||
| Savings deposits | 13.4 | 46.1 | 33.0 | 25.7 | ||
| Preferential savings deposits | 12.8 | 20.4 | 7.1 | 3.6 | ||
| Company savings | 25.3 | 4.5 | 23.0 | 16.8 | ||
| Nonbank financial institutions, total deposits | 22.6 | 29.6 | 24.9 | 19.2 | ||
End of March of respective year relative to end of March of the previous year.
Korea: Growth of Selected Deposits 1/
| 1992 | 1993 | 1994 | 1995 | |||
|---|---|---|---|---|---|---|
| (Percentage change) | ||||||
| Deposit money banks, total deposits | 17.5 | 7.7 | 12.5 | 18.0 | ||
| Demand deposits | 22.4 | -10.4 | 0.2 | 19.0 | ||
| Time & savings deposits | 15.3 | 16.1 | 16.9 | 17.7 | ||
| Time deposits | 7.8 | 3.5 | 12.5 | 24.2 | ||
| Less than one year | -20.0 | -9.4 | 14.8 | 10.0 | ||
| One to two years | 14.3 | 0.4 | 0.3 | 19.6 | ||
| More than two years | 29.1 | 19.0 | 29.7 | 37.0 | ||
| Installment savings deposits | 19.4 | 8.1 | 16.4 | 18.6 | ||
| Mutual installments | 8.0 | 0.5 | 19.5 | 22.2 | ||
| Housing installments | 43.8 | 39.2 | 41.7 | 25.8 | ||
| Workman’s property formation | -9.1 | 0.6 | -10.4 | -15.8 | ||
| Savings deposits | 13.4 | 46.1 | 33.0 | 25.7 | ||
| Preferential savings deposits | 12.8 | 20.4 | 7.1 | 3.6 | ||
| Company savings | 25.3 | 4.5 | 23.0 | 16.8 | ||
| Nonbank financial institutions, total deposits | 22.6 | 29.6 | 24.9 | 19.2 | ||
End of March of respective year relative to end of March of the previous year.
With interest rates of most money market instruments liberalized prior to 1993, the financial sector reform program focuses on the gradual easing of restrictions regarding issue volumes, permissible maturities, and minimum denominations, which still apply to many short-term instruments. The Government plans to study the complete elimination of such restrictions in 1997. The measures taken so far have focused on gradually increasing issue limits for CDs, while expanding the range of permissible maturities at the short end, and lowering minimum denominations. 2/ As a result of these measures, DMBs increased their outstanding volume of CDs from W 10 trillion in 1991 to W 24 trillion in March 1995. As for bond market instruments, yields on corporate bonds and financial debentures with less than two years maturity as well as treasury and public bonds were liberalized in 1993. The issue volume of corporate bonds continues to be controlled by the Association of Securities Dealers in order to stabilize the conditions in the primary market.
c. Bank management, business boundaries, and the supervisory framework
In order to enhance efficiency and competitiveness, the financial sector reform program includes a number of measures to increase the autonomy of bank management and reduce restrictions on financial institutions’ business activities. In addition, it envisages a strengthening of bank supervision and measures to deal with the problem of bad loans.
Even though commercial banks were privatized in the early 1980s, the Government continued to influence their management in a number of areas, such as the selection of senior bank managers, capital increases, dividend payments, and branch network expansions. Since 1993, several measures have been taken to reduce government involvement in these areas: a committee system for the nomination of commercial bank presidents was established, 1/ commercial banks were granted greater autonomy in the expansion of their branch network, 2/ and restrictions on the payment of dividends were eased. 3/ It is planned to gradually phase out the remaining restrictions on dividend payments in the coming years. In addition, deposit money banks were allowed to increase their capital without prior approval of the Monetary Board, and introduce new financial products without prior approval by the Office of Bank Supervision, provided the new products meet existing regulations.
Regarding financial institutions’ business activities, the reform program envisions a lowering of the boundaries between DMBs and NBFIs, and a liberalization of the rules governing the activities of foreign banks and securities firms. The goal is to move toward a system based on three broad types of business: banking, securities, and insurance. 1/ So far, banks have been partly allowed to enter the securities business, 2/ while securities firms have been granted permission to enter the foreign exchange business on a limited scale. In addition, in order to enhance market access for foreign financial institutions, the regulations governing the operations of foreign securities firms in Korea have been eased. 3/
In order to safeguard the soundness of the financial system as competitive pressures increase, the Government plans to strengthen the supervisory framework by integrating the supervision of the banking, securities, and insurance business. 4/ At the operational level of banking supervision, the ongoing implementation of an early warning system similar to the U.S. CAMEL system 5/ is expected to improve efficiency. Within this framework, BIS capital adequacy rules have been progressively phased in and will be applied in full beginning in 1996. BIS accounting procedures for market and interest rate risk are expected to be adopted after 1997. Introduction of a deposit insurance system for DMBs 6/ is scheduled for 1997. 7/
Finally, in order to strengthen banks’ balance sheets, a number of measures have been taken to encourage banks to write off bad loans. In 1994, the Office of Bank Supervision increased the maximum amount of bad loans which banks can write off at their own discretion to W 1 billion, and the maximum amount of write-offs of doubtful loans from 50 percent to 90 percent of their total volume. Moreover, the permitted frequency of charge-offs during a year was increased from two to four times. The Office of Bank Supervision also changed its guidelines for providing against loan losses by requiring banks to increase loan loss reserves equivalent to the volume of expected loan losses, 1/ and introduced a maximum loss-risk weighted bad loan ratio of two percent of total loans which banks have to meet by 1998. 2/ Management performance reviews, which are a part of the CAMEL system, have increasingly taken into account the performance of bank managers in the identification and write-off of bad loans.
In response to these measures, commercial banks used their very high operating profit of W 4.7 trillion in 1994 (compared with W 2.9 trillion in 1993) to write off W 1.7 trillion or almost half of nonperforming loans, and to add about W 2 trillion (around twice the 1993 volume) to loan loss reserves. At the end of 1994, bad loans of commercial banks amounted to W 1.9 trillion or 0.9 percent of total credit. 3/
4. Capital account opening and reform of the foreign exchange system
Although in the past Korea made extensive use of foreign borrowing to finance domestic investment, most external capital transactions remained subject to tight controls and capital flows were closely monitored. In the first half of the 1980s, selective measures to liberalize capital account transactions focused on capital inflows to facilitate the financing of the current account deficit. 4/ As the current account shifted into surplus in the second half of the 1980s, several steps were taken to liberalize capital outflows. 5/ However, notwithstanding these measures, and the partial opening of the domestic stock market to foreign investors in 1992, 1/ restrictions on external capital account transactions have remained extensive.
The Government’s reform program, which was outlined in the 1993 blueprint and elaborated and broadened in the 1994 Foreign Exchange Reform Plan, 2/ envisages a gradual reduction of controls on inward and outward capital flows (Table III.5). The strategy is to liberalize capital outflows at a faster pace and on a broader scale than capital inflows. 3/ While the program entails a significant liberalization of capital flows, it does not imply the removal of all restrictions. For example, foreign investors would only gain limited access to the Korean bond market, and foreign borrowing by Korean firms would continue to be tied to imports of capital goods.
Korea: Schedule of Planned Capital Account Liberalization Measures 1/
Based on the Foreign Exchange Reform Plan presented in December 1994. Reform measures relating to foreign direct investment in Korea are not covered by this plan.
Commercial loans are defined as overseas borrowing which exceed $1 million and maturity of over three years.
With the exception of public enterprises, and, subject to restrictions, foreign-invested companies.
For ships and plants.
Korea: Schedule of Planned Capital Account Liberalization Measures 1/
| Until 1994 | 1995 | 1996-97 | 1998-99 | |||
|---|---|---|---|---|---|---|
| 1. Outflows | ||||||
| Direct investment | Investments exceeding $10 million subject to approval; investment in 14 industries restricted | Investments exceeding $30 million subject to approval; number of restricted industries reduced | Approval system abolished; investment in all nonfinancial industries permitted | |||
| Portfolio investment | ||||||
| Institutional investors | No limits, except for pension funds and investment and finance companies | Limits for pension funds and finance companies abolished | ||||
| Firms | W 300 million limit | W 1 billion limit | Limits abolished | |||
| Individuals | W 100 million limit | W 500 million limit | Limits abolished | |||
| Overseas deposits for asset management | ||||||
| Institutional investors | Prohibited | $100 million limit | Limits abolished | |||
| Firms | Prohibited | $1 million limit | Limits raised | Limits abolished | ||
| Individuals | Prohibited | $30,000 limit | Limits raised | Limits raised | ||
| Credit to nonresidents for asset management | ||||||
| Institutional investors | Prohibited | $10 million limit | Limits raised | Limits raised | ||
| Firms | Prohibited | $300,000 limit | Limits raised | Limits raised | ||
| Individuals | Prohibited | Prohibited | Prohibited | Permitted subject to limits | ||
| Real estate purchases | Limited to certain types of investors and subject to ceilings | Expansion of list of eligible investors; ceilings raised | Expansion of list of eligible investors; ceilings raised | Liberalized for institutional investors and firms; for individuals subject to ceilings | ||
| Issuance of securities in domestic markets by nonresidents | Prohibited | Issuance of equities and equity-linked bonds liberalized; issuance of won-denominated bonds by international organizations permitted | Issuance of won-denominated bonds liberalized | Issuance of foreign-currency-denominated bonds liberalized | ||
| 2. Inflows | ||||||
| Stock market investment by nonresidents | 12 percent ceiling on foreign investment per company | 15 percent ceiling on foreign investment per company | Ceiling raised | Ceiling raised or abolished | ||
| Bond market investment by nonresidents | Limited to public sector bonds with interest rates comparable to international interest rates and convertible as SME bonds | Indirect investment through bond funds allowed | Investment in nonguaranteed, long-term SME bonds allowed | Limited investment in all nonguaranteed long-term corporate bonds allowed | ||
| Issuance of securities abroad | Permitted to subject to overall annual ceilings | Annual ceilings raised | Ceilings abolished for equity-linked bonds | All ceilings abolished | ||
| Commercial loans to finance capital goods imports 2/ | Prohibited 3/ | Permitted for certain types of firms | Permitted for all firms subject to ceilings and SMEs without ceilings | Liberalized for all firms | ||
| Overseas financing of overseas operation | Restricted depending on use of funds | Restrictions eased | Liberalized | |||
| Trade credit | ||||||
| Deferred import payment | Imports for re-export: 150 days | Imports for re-export: 180 days | ||||
| Imports for domestic use: 60 days | Imports for domestic use: 90 days (SMEs: 120 days) | Lengthened | Lengthened | |||
| Export advances | Subject to limits (5 percent of previous year’s export value) | Limit raised to 10 percent of previous year’s export value (SMEs: liberalized) | Limit raised | Limit raised to 30 percent of previous year’s export value | ||
| Export downpayments 4/ | Limited to 80 percent of export value | Unchanged | Unchanged | Limit abolished | ||
| Intermediary trade financing | Advance receipt of export payments before import payments not allowed | Advance receipt period: 30 days | Advance receipt period extended | Advance receipt period extended | ||
Based on the Foreign Exchange Reform Plan presented in December 1994. Reform measures relating to foreign direct investment in Korea are not covered by this plan.
Commercial loans are defined as overseas borrowing which exceed $1 million and maturity of over three years.
With the exception of public enterprises, and, subject to restrictions, foreign-invested companies.
For ships and plants.
Korea: Schedule of Planned Capital Account Liberalization Measures 1/
| Until 1994 | 1995 | 1996-97 | 1998-99 | |||
|---|---|---|---|---|---|---|
| 1. Outflows | ||||||
| Direct investment | Investments exceeding $10 million subject to approval; investment in 14 industries restricted | Investments exceeding $30 million subject to approval; number of restricted industries reduced | Approval system abolished; investment in all nonfinancial industries permitted | |||
| Portfolio investment | ||||||
| Institutional investors | No limits, except for pension funds and investment and finance companies | Limits for pension funds and finance companies abolished | ||||
| Firms | W 300 million limit | W 1 billion limit | Limits abolished | |||
| Individuals | W 100 million limit | W 500 million limit | Limits abolished | |||
| Overseas deposits for asset management | ||||||
| Institutional investors | Prohibited | $100 million limit | Limits abolished | |||
| Firms | Prohibited | $1 million limit | Limits raised | Limits abolished | ||
| Individuals | Prohibited | $30,000 limit | Limits raised | Limits raised | ||
| Credit to nonresidents for asset management | ||||||
| Institutional investors | Prohibited | $10 million limit | Limits raised | Limits raised | ||
| Firms | Prohibited | $300,000 limit | Limits raised | Limits raised | ||
| Individuals | Prohibited | Prohibited | Prohibited | Permitted subject to limits | ||
| Real estate purchases | Limited to certain types of investors and subject to ceilings | Expansion of list of eligible investors; ceilings raised | Expansion of list of eligible investors; ceilings raised | Liberalized for institutional investors and firms; for individuals subject to ceilings | ||
| Issuance of securities in domestic markets by nonresidents | Prohibited | Issuance of equities and equity-linked bonds liberalized; issuance of won-denominated bonds by international organizations permitted | Issuance of won-denominated bonds liberalized | Issuance of foreign-currency-denominated bonds liberalized | ||
| 2. Inflows | ||||||
| Stock market investment by nonresidents | 12 percent ceiling on foreign investment per company | 15 percent ceiling on foreign investment per company | Ceiling raised | Ceiling raised or abolished | ||
| Bond market investment by nonresidents | Limited to public sector bonds with interest rates comparable to international interest rates and convertible as SME bonds | Indirect investment through bond funds allowed | Investment in nonguaranteed, long-term SME bonds allowed | Limited investment in all nonguaranteed long-term corporate bonds allowed | ||
| Issuance of securities abroad | Permitted to subject to overall annual ceilings | Annual ceilings raised | Ceilings abolished for equity-linked bonds | All ceilings abolished | ||
| Commercial loans to finance capital goods imports 2/ | Prohibited 3/ | Permitted for certain types of firms | Permitted for all firms subject to ceilings and SMEs without ceilings | Liberalized for all firms | ||
| Overseas financing of overseas operation | Restricted depending on use of funds | Restrictions eased | Liberalized | |||
| Trade credit | ||||||
| Deferred import payment | Imports for re-export: 150 days | Imports for re-export: 180 days | ||||
| Imports for domestic use: 60 days | Imports for domestic use: 90 days (SMEs: 120 days) | Lengthened | Lengthened | |||
| Export advances | Subject to limits (5 percent of previous year’s export value) | Limit raised to 10 percent of previous year’s export value (SMEs: liberalized) | Limit raised | Limit raised to 30 percent of previous year’s export value | ||
| Export downpayments 4/ | Limited to 80 percent of export value | Unchanged | Unchanged | Limit abolished | ||
| Intermediary trade financing | Advance receipt of export payments before import payments not allowed | Advance receipt period: 30 days | Advance receipt period extended | Advance receipt period extended | ||
Based on the Foreign Exchange Reform Plan presented in December 1994. Reform measures relating to foreign direct investment in Korea are not covered by this plan.
Commercial loans are defined as overseas borrowing which exceed $1 million and maturity of over three years.
With the exception of public enterprises, and, subject to restrictions, foreign-invested companies.
For ships and plants.
Liberalization of foreign direct investment (FDI) in Korea has focused on the gradual extension of the list of industries that are open to FDI, and on measures to facilitate the establishment and operations of FDI companies. The share of industries that are eligible for FDI has increased from 81 percent in early 1992 to 91 percent in April 1995, and is scheduled to rise further to 95 percent by early 1997. 4/ With the introduction of a “one-stop” notification system in 1994, administrative procedures were simplified and shortened. 5/ Furthermore, restrictions on land acquisition, foreign financing of capital goods imports, and acquisition of other companies’ stocks were eased. 6/ Liberalization of outward direct investment (ODI) by Korean companies has concentrated on reducing the number of restricted industries and simplifying approval procedures. 1/ It is planned to allow ODI in all nonfinancial sectors and to abolish the approval system by the end of 1997.
Regarding portfolio capital, the program envisages a more complete and faster liberalization of outflows than inflows. The remaining limits on outward portfolio investment by institutional investors have been abolished, and those for firms and individuals will be eliminated in 1996-97. By contrast, while further increases in the limit on foreign investment in the domestic stock market (currently 15 percent) are planned, it is not certain that they will be completely eliminated by 1999. 2/ Similarly, foreign investment in the domestic bond market, at present only permitted for certain types of public bonds and bonds issued by SMEs, 3/ is set to be expanded to other types of bonds but would remain subject to limits. 4/
While Korean firms have been permitted to issue foreign-currency denominated bonds abroad since the mid 1980s, albeit subject to annual limits on the issue volume, bond issues by foreign residents in Korea were first allowed in May 1995 when international organizations were granted permission to issue won-denominated bonds. The Government plans to widen the range of issuers in the coming years and to permit by 1999 also the issuance of foreign-currency denominated bonds in Korea. 5/ At the same time, limits on overseas issues of foreign-currency denominated bonds by Korean residents will gradually be raised and eventually abolished.
In addition to direct and portfolio investment, the capital account liberalization program covers the following forms of foreign investment: overseas deposits for asset management, 1/ which so far have not been allowed; lending to foreign residents, 2/ which has been restricted to banks and ODI-related operations; and real estate investment, which has only been allowed for institutional investors, general trading companies, and in connection with ODI. It is planned to gradually liberalize these transactions by raising investment limits and broadening the range of investors. However, while restrictions on investments by institutional investors and firms are expected to be eliminated by 1999, 3/ limits would continue to apply to individual investors.
Direct foreign borrowing by Korean firms through commercial loans 4/ has so far been virtually prohibited, 5/ with access to such loans restricted to selected public enterprises and, on a limited basis, foreign-invested companies. 6/ It is envisaged to gradually expand the range of borrowers, initially mainly to SMEs, and the types of projects for which access to commercial loans will be permitted. By 1999, all commercial loans are expected to be liberalized, but borrowing would remain confined to capital goods imports or refinancing of foreign debt. At the same time, restrictions on guarantees and collateral offered by Korean residents to nonresidents would gradually be eased. 7/ Restrictions on foreign borrowing for overseas investment are set to be abolished in 1996.
While trade-related capital account transactions involving outflows, such as export financing, are relatively free of restrictions, transactions involving inflows, such as deferred import payments and advance payments on exports, have remained subject to a number of controls. According to the Foreign Exchange Reform Plan, these controls will be eased substantially but not eliminated completely. In particular, receipt of advance payments on exports would continue to be subject to an overall ceiling, 1/ and deferred payment of imports would remain subject to limitations on the payment period.
While Korea’s foreign exchange system has been free of restrictions on current transactions since 1988, 2/ the enforcement of existing controls on capital flows has required detailed regulations concerning foreign exchange transactions, such as documentation requirements, a foreign exchange concentration system, and restrictions on the operations of foreign exchange banks. The financial sector reform program envisages a significant easing of these regulations in order to enhance the efficiency of the foreign exchange system.
Substantial progress has been made in easing exchange regulations. The foreign exchange concentration system, which obliged residents to sell or deposit the foreign exchange they received at specified financial institutions, was de facto abolished in 1994. The remaining requirement to register with a foreign exchange bank foreign currency holdings that exceed a certain amount is expected to be abolished in 1995. Documentation requirements have been eased in recent years by granting waivers for transactions below certain limits and gradually raising these limits. The Government plans to eliminate the remaining documentation requirements in 1996, but the “real demand” principle for foreign exchange transactions will be retained. 3/
Operations of foreign exchange banks are constrained by ceilings on their net foreign asset and liabilities positions. These ceilings apply to the combined spot and forward positions in relation to a bank’s net worth. 4/ They have been raised several times in recent years and it is planned to increase them further. The Foreign Exchange Reform Plan leaves, however, open whether they will eventually be abolished.
5. Summary
As a result of extensive government regulation and intervention, the development of the financial sector in Korea has lagged behind. After a decade of partial reforms, financial sector liberalization and capital account opening became a top priority in the early 1990s, and in 1993 a comprehensive reform program was presented. The key objective is to deregulate the financial sector in order to enhance efficiency while avoiding financial instability. This is to be achieved through a gradual implementation schedule as well as supporting measures to strengthen the competitiveness of financial institutions and the supervisory framework.
The reform program entails a significant reduction in the degree and scope of government intervention in the financial sector, even though it does not imply complete liberalization in all areas. Implementation of the planned measures has so far been on, and in several cases ahead of, schedule. In particular, most lending rates and more than three quarters of the deposit rates have been liberalized, and a number of measures have been taken to reduce government intervention in the allocation of credit through policy loans, mandatory lending ratios, and credit controls. In addition, reforms to enhance the autonomy of bank management, ease restrictions on financial institutions’ business activities, and improve bank supervision have been introduced. Substantial progress has also been made in reducing bad loans.
Consistent with the planned sequencing of the reforms, the liberalization of the domestic financial sector has proceeded at a faster pace than the opening of the external capital account. The reform program envisages a significant reduction of capital controls but not the complete elimination of all restrictions. The liberalization of capital outflows in such areas as portfolio investment, foreign lending, and trade credit is more advanced than the liberalization of inflows, and, according to the reform plan, would stay ahead, even though further liberalization of inflows is planned. Substantial progress has also been made in easing foreign exchange regulations such as documentation and concentration requirements, which are expected to enhance the efficiency of the foreign exchange system.
References
Bank of Korea (1994), Financial Liberalization and Internationalization in Korea, Seoul.
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. (1994), Recent Changes in the Financial Systems of Asian and Pacific Countries, mimeo.
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.
Galbis, V. (1994), “Sequencing of Financial Reforms: A Review,” IMF Working Paper, WP/94/101.
International Monetary Fund, “Korea—Market Liberalization and Macroeconomic Policies,” SM/90/188, 9/26/90.
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.
Ministry of Finance (1993), Financial Sector Reform Plan of the New Five Year Economic Plan, Seoul.
Ministry of Finance (1993), Third Stage Plan for Financial Liberalization and Market Opening, Seoul.
Ministry of Finance (1994), Reform Plans for Improvements in the Foreign Investment Environment, Seoul.
Ministry of Finance (1994), Foreign Exchange Reform Plan, Seoul.
Nam, Sang-Woo (1992), “Korea’s Financial Reform Since the Early 1980s,” Korea Development Institute, Working Paper.
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.
OECD (1994), Country Study: Korea, Paris.
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.
See Table II.3, chapter II.
An overview of financial sector reforms in the 1980s is included in OECD (1994), and Nam (1992).
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).
This concept is used in Cho and Kim (1995), and OECD (1994). There is, however, no generally agreed definition of policy loans.
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.
See Cho and Kim (1995).
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.
Korea accepted the obligations of Article VIII, sections 2, 3, and 4 in November 1988.
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.