South Korean banking
Seoul survivors
The Economist
January 30~February 5, 1999

HAVING grown up under an authoritarian government, South Korea’s banks are used to doing as they are told. These days, however, they are receiving very different orders. Once they were told where to lend their money. Now a less authoritarian (but still rather bossy) government says it wants them to fend for themselves. That instruction may actually be harder to obey than its predecessors’.

When financial crisis hit a year ago the IMF forced the government into financial reform in return for the $58 billion in rescue funds it arranged. Speedy repairs were essential to the banking system, and the government pumped in tens of billions of dollars. Last year it spent 41 trillion won ($34 billion) recapitalising the banks, disposing of their bad loans, and protecting their depositors. The IMF estimates the total bill will reach 75 trillion won—18% of GDP.

The industry was overhauled. The Financial Supervisory Commission (FSC), the banking watchdog, forced healthy banks to take over five sick ones. Another six merged into three commercial banks. The government sold 51% of Korea First Bank, one of the two most troubled, to a consortium of American financial firms, Newbridge and GE Capital. Meanwhile, the number of people employed by the banking sector has been cut by a third, from 114,000 before the crisis, and more redundancies are unavoidable. For example, Hanvit, formed by the merger of two banks, Hanil and Commercial, and now the country’s biggest, promised regulators it would this year cut its workforce by 1,500—more than a tenth—and close 100 branches.

The banks do not attract much sympathy. They were blamed for bringing the country to the brink of insolvency, through their reckless lending to unprofitable firms. But many of them were victims of the government—they were forced to lend to firms it supported. Now, the FSC expects a “paradigm shift” in bank management: shareholders and directors will hold sway, at the expense of government. Many old-timers have been sacked, and their replacements will have no choice but to look after the interests of their shareholders, and concentrate on increasing profits. Foreign bankers, meanwhile, are expected to bring with them sophisticated information technology and managerial skills.

So far so good. Yet analysts have not shaken off all their gloom about South Korea’s banks. Their non-performing assets stood at 8% of outstanding loans at the end of last year—very low by the region’s depressing standards. But they are expected to grow. Many big firms have yet to go through the financial restructurings they need. This will be expensive for the banks, entailing debt-for-equity swaps, debt forgiveness and reduced interest rates on bank loans.



Last year the banks went through similar restructuring. That, coupled with a ruling last July making them value all their bonds and shares at their market price, contributed to huge losses—after tax, the 22 commercial banks combined lost 14 trillion won. This year will not be much better. Banks will have to increase the provisions they make against some loans from 2% to at least 20%. Into that category fall many of their “policy” loans to once-favoured companies, now bust.

So it is hardly a brave new world for South Korea’s banks, and it is not certain their managers can cope. They do not have the skills they need to develop businesses other than lending. This will be crucial, as bank loans are shrinking as a proportion of the corporate sector’s sources of funding (see chart). Banks specialising in, say, private banking or in dealing with profitable small firms, may do quite well. But the big commercial banks, which used to depend on business from the large conglomerates, may find it hard to be reborn as prudent and innovative institutions. That might take another financial débâcle.