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Asia-PacificJuly 1 2003

Financial reform tests new government

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South Korea’s financial fortunes are proving a tough nut to crack for President Roh Moo-hyun and his ministers. Kim Mi-hui reports.

The mood was hardly jubilant when South Korean President Roh Moo-hyun celebrated his first 100 days in office on June 4. Having weathered a series of storms including the nuclear threat by North Korea, the war in Iraq that hampered exports and the ongoing SARS virus in Asia, the new government already looked worn out.

The biggest worry for the democratic leader at the moment, however, may be the grim economic conditions at home that have some recalling with a scowl the major financial crisis of 1997-1998, when the country had humbly to accept a bail out from the International Monetary Fund (IMF).

After recording a sturdy growth of 6.3% last year, economic expansion stopped at 3.7% in the first quarter of this year. Even the most optimistic experts predict the year-end figure will stay below the 4% range.

In addition to the slowdown in development, South Korea is plagued with a high-profile accounting fraud at one of its leading conglomerates, SK Group; a 53-month low consumer sentiment in March; widened current account deficit to $1.19bn at the end of the first quarter; and the burst of the credit bubble.

Many market observers are concerned that the dim macroeconomic prospects, when mixed with the plight of the credit card industry and rising household debt, may lead the new administration to abandon its commitment and resolution to market reform.

Such delays would disappoint many Koreans, who harbour especially high expectations for Mr Roh, since he campaigned hard for reform to the chaebol (large conglomerates) prior to the election. He showed zeal for restructuring the finance sector, launching an economic monitoring team to discuss business strategies even before his inauguration.

The appointment of Kang Chul-kyu – who is known as “Mr Clean” in the financial circles for his stick-to-the-rules philosophies – as the chairman of the Fair Trade Commission was seen as a clear message that the government would be firm on conglomerate reform. Lee Jung-jae, who took office as chairman of the Financial Supervisory Commission, also vowed commitment to market flow.

Investigation falters

The government has already strayed from course on several occasions, though. For one, it planned to launch a probe of the nation’s six groups – Samsung, LG, SK, Hyundai, Hyundai Motor and Hyundai Heavy Industries – on alleged illegal transactions in the second quarter, but it postponed investigation citing unfavourable exterior conditions.

“We have decided to flexibly adjust the timing for the investigation into the allegations in consideration of the situation in Iraq and the North Korean nuclear crisis,” Korea’s Fair Trade Commission said in March.

However, the SK scandal began grabbing international attention and the hard-earned trust of foreign investors was visibly waning – South Korea saw foreign direct investment in the first quarter halve from last year to $1.18bn, the lowest since the financial crisis. The government is now busy reconfirming its dedication to reform.

Deputy prime minister and finance-economy minister Kim Jin-pyo stressed in May that the government would not stop the reform drive under any circumstances. “Reform in the four key sectors – corporate, financial, labour and public – will continue as planned at full speed,” he told investors in Washington. “The accounting fraud at SK Global showed that irrational practices still remain and measures are needed to address the problem.”

Privatisation pledge

The ministry pledges specifically to continue with privatisation of Chohung Bank, as well as other banks and investment trust companies that have received public funds. It also says it would simplify the intricate web of more than 40 laws, while increasing transparency and aligning corporate governing practices with global standards.

It is already well into the Chohung Bank project, which saw some delay during the previous administration when critics accused it of rushing the sale of the state-owned bank to receive credit for the privatisation.

In mid-June, the Korea Deposit Insurance Corp (KDIC) and the Finance-Economy Ministry said talks are well under way with Shinhan Financial Group on the sale of Chohung Bank. The state-run KDIC and Shinhan have been in talks on Shinhan’s takeover of Chohung, South Korea’s fourth largest lender, since late January when Shinhan was named the preferred bidder. KDIC has a controlling 80.04% stake in the bank.

Profits down

Mr Roh’s administration still faces many other challenges. For instance, banks’ profits are at rock bottom, leading many foreign experts to note that South Korean banks are too vulnerable to the economic cycle.

The nation’s 19 local banks saw their net profit fall by 97% in the first quarter from 1780bn won ($1.49bn) a year ago to 46.5bn won, as they set aside more loan-loss provisions against SK Global and troubled credit card companies. Overdue loans to Hynix Semiconductor and Hyundai Engineering & Construction are also said to have contributed to the worsening performance.

Kookmin Bank, Korea’s largest, saw the sharpest profit drop with a decrease of 598.3bn won. Korea Exchange Bank ranked second, posting a fall of 245.6bn won, followed by Hana Bank with 116.4bn won and Korea First Bank with 90.7bn won. These lowly figures have led to the fall of stock prices of the major banks.

Banks fight back

Accordingly, the banking sector is fighting the recent move by some lawmakers to curb their asset management business, especially trust accounts. The Finance and Economy Committee at the National Assembly is mulling over consolidation of the regulations on asset management that are currently being applied separately to banks, investment trust companies and asset management firms.

Banks, however, argue that they are likely to lose one of their major income sources if the change is enacted. They also say the separation of the money trust business will limit their role as an intermediary institution, as well as their customers’ rights to choose the financial product that they want.

Goodmoring Securities estimates that local banks have a total of 60,000bn won in money in trust accounts under their management, and they usually reap an annual average commission of 0.9% from these assets.

Credit crunch

Yet another major problem for the government is the credit crunch. According to the Korea Federation of Banks, the number of credit defaulters in Korea exceeded three million at the end of April for the first time. The figure is 13.6% of the nation’s 22.6 million economically active adults.

“The sharp rise was mainly due to soaring defaulters associated with reckless credit card uses,” Yun Han-keun, director general of the financial market department at the Bank of Korea, says. “Unless the rising overdue payment rate at card firms slows down, the trend will continue for the time being.”

As a result, layoffs are widely expected in the credit card industry as companies in the sector attempt to raise capital and pare down costs to solve their liquidity problems. Some credit card firms are already implementing hiring and pay freezes, while moving towards a performance-based compensation system from the seniority-based one.

“The credit problem is probably the most serious in the financial sector right now, though it is my impression that it is not significant enough to bring about long-term financial instability,” said Kim Ki-hwan, advisor at Goldman Sachs in Seoul.

Capital deal

To deal with the issue, in April the government ordered the local credit card companies to hike capital by 4000bn-5000bn won this year in return for being privileged to have their debts and bonds amounting to 5000bn won rolled over. They were allowed to hike rates on cash advance services by three to five percentage points.

On April 4, nine local credit card firms said that they would raise a total of 4550bn won in capital in an effort to defuse a liquidity concern among investors. In early June, eight companies, including Kookmin Card Co and LG Card Co said they would raise an additional 1850bn won in the third quarter in a bid to head off a liquidity concern still reverberating among investors.

Rating boost

But it’s not all bad news in the banking sector. Woori Bank was recently put in the spotlight for improving its balance sheets and disposing bad assets. Standard & Poor’s increased the long-term rating on the bank to BBB- from BB+, citing improvement in asset soundness and profitability as well as systematic credit risk management involving households and small firms.

Korea Exchange Bank, the nation’s sixth-largest commercial bank, is also being considered for an investment from a US financial institution, which concluded due diligence on the finances of the lender’s headquarters early in May and is now deliberating a final decision.

The government has also made some monetary efforts to help the economy recover. It allocated 53% of its annual budget in the first half of the year, increasing government spending by 10,000bn won compared with the same period last year.

In March, the Bank of Korea also injected 2000bn won into the nation’s bond markets, through reverse purchases of agreements, and lowered the short-term interest rate by 25 basis points to 4% in May.

Upgrade goals

Other signs that the government is sticking to its goal of upgrading the financial sector include its efforts to improve service in the banking field and its hands-off approach to large corporate problems.

In March, the Financial Supervisory Service publicly announced the names of local banks that drew the largest number of complaints from customers. According to the service’s consumer protection centre, Kookmin Bank headed the list, followed by Mirae Asset, SK Life Insurance, Daehan Trust & Securities and Hyundai Card.

In addition, the government promised repeatedly it would keep out of the ongoing SK Global issue. SK Global admitted to having inflated its 2002 earnings by 1500bn won.

“Because we believe in markets, firm restructuring throughout our economy is now driven by markets,” says finance-economy minister Kim, promising further efforts in the future, such as making way for class action lawsuits.

The ministry said it would also work to internationalise accounting practices by requiring CEOs to certify their companies’ financial statements; building walls between the consulting and auditing functions of accounting firms; and considering forced replacement of accounting firms every six years.

On the other hand, many experts are urging the new government to create a unified channel for communicating with investors, saying that foreign investors are confused by mixed policy messages coming from the different departments of the administration.

A group of former finance-economy ministers who served under Kim Dae-jung stressed recently that a single, clearer voice on agenda will make implementation much easier.

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