Revamping the Korean Financial Sector for the 21st Century
Milton S. Kim
Chairman
Good Morning Securities
I am pleased to have this opportunity to talk about changes in the Korean financial sector as we look toward the future and hope for a better tomorrow. Indeed this is a great honor speaking before such a distinguished group of business leaders, government officials, academics, and members of the media.
As you are all know, Korea, along with the rest of Asia, has gone through a dramatic turn of events in recent years. It was just over two years ago that the financial panic, which started in Thailand in July 1997 finally reached Korea, battering what was once the world's 12th biggest economy and bringing it to its knees. Standing on the verge of national bankruptcy, Korea had no choice but to turn to the IMF and the international financial community for assistance.
Working closely with the IMF, the World Bank, and allies including the U.S., the Korean government adopted a comprehensive policy to stabilize the financial markets and restructure the economy. At the risk of sounding immodest, I think the interim results have been impressive. After contracting by -5.8% in 1998, the Korean economy made a dramatic turnaround to post an estimated growth rate of 10.1% in 1999. At the same time, inflation dropped from 7.5% in 1998 to a miniscule 0.8%
Meanwhile, the foreign exchange and the financial markets have also improved considerably. The foreign exchange rate has stabilized in the low -1100 won/US$ range, after reaching almost 2000 won/US$ at one point in December 97. Korea's foreign exchange reserves have now risen from a precariously low US$8.9bn at the end of the 1997 to US$78.4bn as of mid-February this year, boosted by the healthy current account surpluses and the steady inflow of foreign portfolio and direct investment. The current account balance swung from a deficit of US$8.2bn in 1997 to a whopping US$40.6bn surplus in 1998 and an estimated US$25.0bn in 1999.
At the same time, Korea's foreign debt picture has brightened considerably. Total external liabilities stood at US$136.4bn at the end of December 99 from US$159.2bn at end 1997, while short term debt now only accounts for 27.9% of total debt.
Interest rates have also come back down to earth. Market rates reached almost 30% during the worst of the crisis as the government tried to attract foreign capital, but have fallen back down into the single digits and seem to be holding steady. After maintaining a high interest policy during the worst of the crisis, the Korean government switched back in 1999 and tried to lower market rates to help stimulate the budding economic recovery. Even after the outbreak of the Daewoo problem, the benchmark 3-year corporate bond yield has stayed at or under 10%, thanks in large part to the government's active efforts through the Bond Market Stabilization Fund to keep rates low.
Meanwhile, with the economy entering into a full-fledged recovery and companies capitalizing upon the improving business conditions, the Korean stock market has shown great vigor over the past year. The KOSPI index rose from the 300-point level in mid 1998 to top the 1000-point level in 1999 and close at 1028.07 at the end of 1999. At the same time, the KOSDAQ, Korea's equivalent of the U.S. NASDAQ, has shown even more robust growth, with the daily trading volume now surpassing even that of the main Korea Stock Exchange.
With these tangible improvements in Korea's financial and overall economic situation and the return of foreign investor confidence, Korea's credit ratings have regained investment grade level, and further upgrades by the major agencies such as Moody's and S & P's are expected.
Now, allow me to talk more specifically about the changes that have taken place in the Korean financial sector.
The Korean financial sector has been going through a dramatic restructuring process which is still ongoing. With survival itself being the first and foremost task for everyone, financial institutions began to cut away their fat and restructuring in 1998. In the process, more than a few institutions were forced to close their doors or be absorbed by others when their restructuring efforts or their chances of survival were judged to be insufficient.
Among the 2,102 financial institutions (banks plus non-banks) in existence at the end of 1997, 347 that were through to have little or no chance for survival were exited from the market by the end of 1999, being dissolved or taken over through M&As. In other words, a full 16.5% of the firms operating at the end of 1997 disappeared. Among banks in particular, the number of commercial banks has been reduced from 27 to 17 and the total number of employees reduced by 26.7% from 130,016 to 95,307.
Meanwhile, the financial institutions deemed salvageable received public funds on the condition that they make self-efforts to rationalize their management and improve their business structures. Of the 64 trillion won set aside by the government for financial sector restructuring, 20.5 trillion won was spent on buying out bad loans, while another 43.5 trillion won was used to build up their capital and pay back their deposits.
One key characteristics of the restructuring process has been the role played by foreigners. In addition to the valuable advisory services being provided by leading foreign investment banks and financial institutions, foreign investment has played a critical role in revitalizing certain financial institutions. For example, an agreement was reached on the sale of Korea First Bank with Newbridge Capital, which is finalizing its preparations for taking over Korea First Bank's management and operations. Korea Exchange Bank also stabilized its operations by attracting foreign investment, mainly from Germany's Commerzbank. Foreign investment was not limited to banks. In fact, our own Good Morning Securities benefited greatly from sizeable investment from foreigners.
Financial sector restructuring was significant not only because failing firms were weeded out of the market but also because it helped people to change their traditional business attitudes and practices. In other words, the forced exit of certain banks helped destroy the myth of "too big to fail" and instill market principles and accountability as the new guiding market rules. In addition, by raising the level of depositor protection and the financial regulatory system to international standards, the foundation has been laid for the financial sector to properly play its function of financial intermediation, and financial institutions must now adjust their management style and credit practices focus on commercial value and profitability.
The headway progress made in financial sector restructuring his significantly lowered the level of bad loans at financial institutions and improved their asset soundness. Commercial Banks' BIS Capital adequacy ratios have risen from 7.04% at the end of 1997 to 0.84% as of the end of June 1999, with all of the banks above the recommended level.
As we enter into the 21st century, the business environment for the financial sector can be expected to change dramatically. To begin with, the growing trends of digitalization and cyberization should become even more pervasive. With continuing advances in information and communications technology, cyber-related activities should open up a new era of unprecedented competition unfettered by time or spatial constraints. The ease and speed of data gathering will be primary determinants of competitiveness in the cyber-economy, and as the cyber-economy expands, financial institutions will have no choice but to offer a more diversified and competitive range of financial products and services. In addition, this new style of business will lessen the effectiveness and pertinence of traditional considerations such as national economic and financial policies and force institutions to conduct their business from an international or global rather than a domestic perspective.
As competition intensifies and distinctions between financial services become blurred or minimalized, the industry trends toward consolidation and universal banking financial services should continue. To strengthen their global competitiveness and maximize their range of available financial services, firms will increasingly pursue "mega M&As" not only across national borders but sectoral boundaries as well.
In addition, market players will increasingly view on another not only as competitors but also as potential and/or partners for strategic alliances. As such, trust based on openness and transparency will be important in determining what opportunities are available to which institutions and will therefore constitute a critical component of a firm's competitiveness.
At the same time, trustworthiness will become more crucial to financial institution since the changes within the industry I have just mentioned will undoubtedly lead to changes in their clients' behavior patterns. As clients are exposed to a wider range of competition and services, they will be increasingly drawn to firms which have consistently demonstrated their credibility. In other words, the market mechanism should ensure a "flight to quality" in which the strong continue to attract more and more customers while the weak will see their business decline.
Against this background, Korean financial institutions must focus on improving their asset soundness and financial health as opposed to external growth. With the adoption of forward-looking criteria (FLC), banks needs to strengthen their credit analysis and risk management abilities if they are to benefit from the flight to quality. Once they have established their asset quality and solidified their image as a sound financial institution, it will be easier for them to raise low-cost financing and achieve greater economies of scale. At the same time, it will be that much easier for them to find partners for strategic tie-ups, joint ventures and M&As and also attracting additional investment. In this sense, maintaining their BIS capital adequacy ratios at high levels is a top priority.
Another critical task will be offering more diversified financial products. As the market matures and more and more foreign players enter the market. Korean institutions will eventually need to expand their product range to include new items such as high-xxx bonds, asset-backed securities and mortgage-backed securities or new services such as wrap accounts.
The government must also play a vital role in the further development of the financial sector. In a general sense, the government should allow the market mechanism to serve its proper function by making sure that the relevant regulatory systems and agencies promote transparency and accountability. Management must be held accountable for their performance, while the outside-director and auditing systems must also be strengthened.
Also, with the global trends of deregulation and universal banking, the government should prudently loosen current restrictions on the range of activities open to financial institutions to allow them to provide a more complete range of services, while promoting further industry consolidation especially among secondary financial institutions. The Korean investment trust sector in particular is in bad need of a drastic overhaul.
In addition, systemic and infrastructural changes are needed to allow the financial sector to serve its primary function of financial intermediation more efficiently. One key concern is vitalizing the bond market, which is lifeless especially in comparison to the booming stock market. The implementation of the mark-to-market accounting system for bonds slated for this July will be a crucial step in the right direction to boost the liquidity and transparency of the bond market and in facilitating accurate credit analysis. The government should also consider measures to nurture specialized bond dealers and open-ended mutual funds, among other things. Another key institutional change should be strengthening accounting and disclosure standards to suit customer needs and thereby build up trust and credibility.
While the remaining restructuring tasks will indeed be difficult, I think Korea will be up to the task. Having learned the main lessons of the Asian crisis, Korea must ultimately embrace an open market economy based on democratic principles. Structural reforms must be completed so that the market mechanism functions properly and ensures the optimal allocation of resources. Granted, some reforms may be harder to pursue than others, especially under given circumstances, but in the longer run they are for our own benefit.
Meanwhile, infrastructure and the socio-cultural environment must evolve to cultivate a knowledge-based society. In Korea, top priority is already being placed on beefing up the information-technology and Internet infrastructure, while the educational system is also being revamped to foster creativity and innovation. In addition to the government's efforts, the private sector is also taking an active role in nurturing venture firms and allocating the necessary resources.
I would like to add that most of the things I have described are not specific to Korea but apply throughout Asia and even to most parts of the world. As such, we can work together in pursuing many of these tasks. With the dawning of a global information society, it is apparent to everyone that cooperation must be pursued side-by-side with competition in the international arena. Recent events have clearly demonstrated that with the growing economic interaction and inter-linking of financial markets, what happens in one economy is rarely localized and can even affect the entire globe. As such close coordination is needed to adequately deal with major issues such as the financial crisis of 1998. At the same time, with the rapid advances in telecommunications and Internet technology, there is a growing need to work in conjunction to designate universal standards and thereby maximize the benefits and applications of these technological gains.
I look forward to he new millennium with great enthusiasm. The recent economic crisis within Asia was indeed a painful experience but now it seems that everyone is regaining their feet. I am a firm believer in the growth potential of the Asian economies. I think the Asian nations should try to step forward and show the world that the "Asian Economic Miracle" was not a myth. Having learned our lessons, we should demonstrate we are capable of brisk, yet sustained and balanced economic development.
Thank you for your attention.