KOREA Structural Reforms in the Financial

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KOREAStructural Reforms in the Financial
Corporate SectorsProgress and Issues

• Sri-Ram Aiyer
• Country Director, Korea Department
• East Asia Pacific Region
• The World Bank

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MAIN ELEMENTS OF KOREAS STRUCTURAL REFORM PROGRAM

• Establishment of a sound, market-based financial
  system
• Corporate sector reform to restructure corporate
  finances, improve corporate governance, and
  enhance competition
• Reorienting the role of government from
  dirigisme to support of private activity
• Improving labor market flexibility and
  strengthening social safety nets
• IN ORDER TO
• Strengthen market economy and provide impetus for
  efficient allocation of scarce financial
  resources to high return activities
• Lay a new foundation for growth better attuned to
  todays economic imperatives, including
  globalization.

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FINANCIAL SECTOR REFORM

• Unified financial sector regulatory and
  supervisory body established, and functioning
  with increasing autonomy
• Prudential regulations upgraded, forward looking
  criteria to be adopted for loan classification
• Clear principles and processes adopted for use of
  public resources in financial sector
  restructuring/recapitalization
• Established Korea Asset Management Company to
  manage and quickly dispose financial sector
  assets acquired by Government

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FINANCIAL SECTOR REFORM

• Speedy resolution of weak banks following
  diagnostic audits, through closure/merger/govt
  acquisition
• Restrictions on foreign entry removed, two banks
  being sold
• Resolution and restructuring strategy for
  non-bank financial institutions adopted
• Upgrading of supervisory capacity and credit
  capacity of banks to begin

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DEVELOPMENT OF CAPITAL MARKET

• Drastic liberalization of regulations on foreign
  participation
• Diversification and deepening of market through
  encouragement of new institutional investors
• (e.g. mutual funds) and asset securitization
• Strengthening of securities market
  infrastructure improvement of prudential rules,
  enhancement of market competition, improvement of
  financial accounting and disclosure,
  strengthening of market institutions
• Development of bond market, including
  standardization of government bond issues and
  development of market-makers network

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CORPORATE GOVERNANCE

• Strengthening of responsibilities, independence
  and accountability of corporate boards
• Enhancement of minority shareholder and
  institutional investor rights
• Enhancement of creditors rights through
  improvements in bankruptcy laws and laws on
  secured lending
• Adoption of accounting, auditing and reporting
  standards consistent with international best
  practicefor both financial and non-financial
  corporations
• Enhancement of role of independent professional
  bodies in standard-setting and regulation in
  accounting and auditing
• Introduction of audit committees of boards of
  directors

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COMPETITION POLICIES

• Strengthening of Fair Trade Act and its
  enforcement
• Commitment to fully enforce competition laws in
  the restructuring of chaebols
• Tightening of rules against transactions between
  related corporations and parties
• Institutional strengthening of Korea Fair Trade
  Commission and increasing its sanctions powers
• Removal of restrictions on holding companies
• Major liberalization of foreign investment and
  MA regime, including allowing hostile takeovers
• Simplification of customs and certification
  procedures

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CORPORATE RESTRUCTURING

• Establishment of a framework for corporate debt
  workouts led by creditor banks under guidelines
  established by FSC and linked to financial sector
  restructuring
• Debt workout process supported by policies to
• limit emergency loans
• reduce cross-guarantees
• limit concentration of credit
• facilitate debt-equity swaps, asset sales, and
  MAs
• remove tax disincentives
• tighten regulations on intra-chaebol transactions

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• Closure of insolvent, non-viable corporations
• Establishment of Capital Structure Improvement
  Plans for implementation and monitoring of
  restructuring by top 5 chaebols

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THE PLUS SIDE

• Structural reforms including enacting of
  legislation announced and pursued by Government
  with consistency and clear commitment, despite
  difficult economic and social conditions.
• Complemented by consistent macro economic policy
  adjustments on fiscal and monetary side as
  economy stabilized and external position
  strengthened significantly, led by exports.

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THE PLUS SIDE (Contd)

• Led to restoration of confidence (e.g., Rating
  upgrades ) in early 1999.
• Domestic demand has also picked up, another sign
  of public confidence
• FDI and portfolio capital inflows registering
  record increases
• Stock market booming
• GDP growth forecasts being adjusted upwards
  monthly by Government and other analysts

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THE FRAGILE ELEMENTS

• Banks still holding large stocks of NPLs.
• Early 1999 Govt. KRW 100 tril. Market KRW
  120 tril.
• May 1999 Govt. KRW 130 tril. Market KRW
  160 tril.
• All crises show that NPLs are a moving target
• Forward looking criteria will require additional
  provisions
• ( est KRW 33 tril. while KAMCO / KDI have KRW 10
  tril. left )
• SME forced to restructure in 1998, due to credit
  crunch
• Most large chaebols (1-64) began restructuring in
  late 1998, with three of the top five unable to
  meet their end 1998 d/e target.

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THE FRAGILE ELEMENTS ( Contd)

• FSC announcement of creditor banks review of
  implementation of restructuring plans showed 23
  of 59 chaebols ( 6-64 )as unsatisfactory or
  lower. Process so far has been of limited scope
  ( dominance of smaller chaebol ), and limited
  effectiveness ( financial or operational )
• Largest 30 firms account for 15 GDP and 5 of
  employment, but over 45 of total financial
  assets
• Their loss making, unviable affiliates absorb
  scarce capital, leaving little for high rate of
  return activities, including SMEs. Exit is
  important to permit entry.
• Best way to ensure high quality, sustainable
  recovery is to let capital flow to investments
  with highest returns.

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THE FRAGILE ELEMENTS (Contd)

• How to speed up introduction of modern credit
  culture?
• ( e.g. quick sale of two banks )
• The NBFI sector - KRW 543 tril. at end 98, or 130
  of GDP, compared with KRW 577 tril. or 137 of
  GDP in banking system- is excessively short-term
  oriented and held by chaebols through ownership
  and management controls. Are their allocation
  processes transparent?
• Are corporate governance reforms being adopted
  uniformly? Is there enough transparency in most
  firms?

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THE FRAGILE ELEMENTS (Contd)

• Is disposal of KAMCO assets proceeding quickly
  enough to complete resolution?
• Is access to credit the only impediment for SME
  development?
• Alongside high unemployment, urban poverty has
  doubled since the crisis - Beside the safety net,
  is there any remedy other than high growth?

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THE CRISIS ABATES

• Last years concerns
• How far will Koreas GDP fall?
• When will the recovery commence?
• This years concerns
• The recovery is underway in Korea, and the rest
  of Asia
• ( e.g., Japan )

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TO SUM UP

• Are the underlying issues in the real economy
  solved in Korea?
• Not yet. Took years in US.
• Is Koreas recovery of high quality and
  sustainable?
• With continued restructuring and reform,
  especially in corporate and financial sectors,
  and changes in behavior (governance /
  transparency, competition / anti-collusion,
  value-addition ),
• it can be sustained, given the track record,
  human capital base and the Presidents visionary
  leadership and
• Korea could then become a leading influence in
  Asia