Financial Journalist

Banking World Hong Kong January 1998

Finally, after years in a spending blow-out, Korea finally got the bill

By Gerry O’Kane

The Korean banking sector has had a tough year, no getting away from it. And non-performing loans threaten to mount like Everest as exposure to the chaebol overwhelms loan portfolios. Add to that, the closure of more than a dozen merchant banks burned to the ground in the Won speculation and the mounting pressure to meet international standards, and the prospects for banks and the economy generally seem glum at best.

In some quarters, Korean commercial bank executives blame their plight on the need to comply with the Bank for International Settlement’s over-sticky capital adequacy ratio (CAR) requirements. For some international analysts this argument holds as much water as the one that holds that the International Monetary Fund’s piece-meal distribution of bailout medicine is the real cause of economic collapse.

In the first case, analysts see Korea’s bankers as blaming the fire inspector for warning everyone about blocked firewells, in the second, they see them blaming the fire brigade for the actual fire.

The fact is that the traditional structure of the loan system is likely to cripple many commercial banks. Observers only see the Kookmin Bank (KMB) and the housing and Commercial Bank of Korea (HCB) as being relatively unfazed. Overall the Korean banking sector is suffering. Operating profitability is low and assets are regarded as low quality. For too long the banks have been lending on hope, often buoyed by cronyism. The chaebol account for over 70 per cent of GDP and while figures differ, loans to them have dominated portfolios. With the regional economic crisis deepening, and Korea’s construction sector sinking domestically, many chaebol face troubled times.

To put it in perspective, Korea’s car manufacturer, Kia owes Won 11.5 trillion. According to some analysts, who are loathe to be quoted on the record, the chaebol’s own records indicate the banks are owed something on the order of Won 23.491 trillion. Analysts are sceptical of these figures because they would suggest Kia’s debt alone represents nearly 50 per cent of chaebol debt. However the burden cuts, it’s clear to bank sector watchers that lack of critical oversight of the banking system is finally coming home to roost.

Liquidity crunch
Everyone is suffering from lack of liquidity. The government’s Office of Bank Supervision OBS) has been insisting - even before the currernt crisis blew up - that the commercial banks get in line with BIS regulations. By June of last year they had already fulfilled the minimum 83 per cent of the 8 per cent CAR, well ahead of the December, deadline. Then the banks were told to get their CAR provisions up to the standard 100 per cent.

Because of this, banks called in loans considered too risky. Letters of credit which were considered too risky were denied - something of a novelty. But it all meant more bad news for industry. Hardly weeks after they met the 83 per cent requirement, they complied with the 100 per cent rule. Indeed, by last July, all 33 Korean banks had met the 8% CAR.

The question is, will they be able to maintain that level this year? The most optimistic answer is the outlook is hardly promising. And if they cannot comply with the BIS rules on lending by June, they have been warned by the International Monetary Fund they will be closed. That’s bad news for Korea Inc, at least initially, and bad news for the banks.

As the real dimensions of the financial situation rise from the murky depths, loan defaulters will come out of the muck, too; firms that might have survived will not get the high-risk loans they will need to keep going. And last, but hardly least is the equity part of the equation.

Capital adequacy ratios can be built up and maintained through revenues or through cash injections courtesy of the equity market.

With revenues plummeting and the stock market in a miserable state, it would seem the banks are running out of options. To make matters worse, while CAR regulations might be being met, the reality of Korea bad loan provisions is that they are well-below international expectations. Add to these woes the worsening forex debt and the countries banking sector faces even grimmer prospects.

Two banks which do not fall into the same dismal category, are KMB and HCB, both managing to keep their distance from the chaebol as it happens. KMB focused on building up its retail business and the fruit of that effort was the largest network in the county.

More than 50 per cent of its loans are personal rather than corporate. Result? Repayment rates are twice the sector average. Similarly, the HCB has a high per centage of its loans out to private house-holds though as mortgages it must be said, rather than personal loans.

The merchant banking system is in even more of a crisis. Nine institutions were suspended in November and December alone. That wrinkle brings the closure tally to date to 14 out of 30 merchant banks. Few are expected to recover fully, if at all. Hit by poor forex dealing positions and the subsequent liquidity crunch, they are unable to pay back loans. The survivors have to seek more capital or merger partners to continue: Not a happy beginning to the New Year.

Korea, banking, poor lending, non-performing loans