The Wall Street Journal published an article on 27 March 2009 in which the present South Korean president, Lee Myung-bak, took pride in describing “How Korea solved its banking crisis and the lessons Korea learnt from the experience in the late ‘90s”. Little did he realize that he would have to now deliver a speech on how Korea is going to tackle its banking crisis that has been looming for the last year.
The near-collapse of Korea’s financial system during the 1997 Asian financial crisis was attributed to policies that established strong capitalistic ties among the Korean banking sector, the government, and the chaebols (family-controlled Korean business conglomerates with intense government support,) and the lack of an adequate risk governance framework. The symbiotic relationship of the chaebols with the government led to moral hazard and serious structural distortions, with excessive risk taking by banks, over-borrowing by the chaebols, and unstable debt-equity positions. The lack of prudent supervision and financial controls made Korean banks vulnerable to the 1997 crisis that ultimately resulted in financial insolvencies and numerous bank closures.
Fast forward a few years and South Korean bankers are in the federal spotlight again, and for reasons similar to the 1997 crisis. What happened to all of the lessons learnt from the banking closures, restructuring, and bailouts?
South Korean regulators have closed the nation’s 20 weakest “savings banks” in the past year. They have unveiled 200 cases of illicit lending and lax oversight resulting in corrupt and illegal practices by bankers to cover loan default losses.
South Korea’s savings bank industry was born in the aftermath of Asia’s 1997 financial crisis, when regulators allowed private lenders and rural cooperatives to call themselves “savings banks” to offer loans at higher interest rates than major banks to working-class people and companies without adequate collateral. Subsequently, the state granted deposit protection equal to insurance at nationwide lenders and eased lending rules to permit the small banks to lend to the property market. In 2005, when low interest rates fueled a property boom, savings banks increased their exposure to real-estate-project financing loans. South Korea’s sluggish real estate market following the global financial crisis in 2008 led to capital and liquidity shortages and loan defaults. This, coupled with corruption and malpractices, was the primary reason for the current downfall of the small savings banks.
Bank closures have wiped out many uninsured depositors’ and bond owners’ savings that belonged primarily to working-class citizens’ retirement funds. The Korean Deposit Insurance Corporation guarantees up to a maximum of 50 million won (approximately $43,000 in U.S. dollars). Media reports that 88,000 depositors and bank bond owners who had deposits far exceeding the insurance coverage are left with little or no recourse to recover their lost money. Four executives of savings banks have committed suicide in the last six months when they were summoned by prosecutors for reasons such as alleged embezzlement, breach of fiduciary duty, or misappropriation of funds by management.
The Korean government is currently discussing restitution measures such as payback of the insured amounts and state-backed microloans to small businesses. The suspended banks may be taken over by the bigger banks. Indeed, the nation’s four largest financial holding firms – Woori Finance, Hana Financial, KB Financial Group, and Shinhan Financial Group – each have already bought one troubled savings bank put up for sale by the government last year. Market watchers fear that any further acquisition of such assets would hurt the health of the country’s bigger financial firms. The Financial Services Commission aims to close the deals by August. Regulators are hopefully aware that downsizing through restructuring of the industry is only a transient solution to the crisis.
Theoretically, we can assign multiple reasons for the current collapse of the Korean savings banks: the U.S. subprime mortgage crisis resulting in a slump in the Korean real estate market; the acute foreign currency liquidity crunch in 2008; depreciation of the Korean won; lack of adequate controls/policies; corruption; malpractices; or simply global contagion.
But what about those uninsured depositors, retirees, and bond holders trying to recover their hard earned money that has vanished in the crisis? Suicides by executives and restructuring of banks offer very little solace to restore a common man’s confidence in the Korean banking industry or to bring back retirees’ pension money. It is critical to distinguish financial liberalization from trade liberalization, and to create a sustainable risk management and governance framework in the reform process to ensure comprehensive market reform based on ethics to restore market trust and integrity.
The recently released annual report by the Bank of International Settlement rings an alarm regarding the risky behavior by banks that is threatening the global economy; if the underlying structural problems are not resolved, there is a risk of another crisis. Focusing on availability and standardization of underlying data to help prudential regulators recognize risks and collaborate on mitigation remains critical, and will be an important point of focus for the newly organized Systemic Risk Council (SRC) co-sponsored by CFA Institute and Pew Charitable Trusts.