Korea’s Financial Reform: A Systemic Risk Approach Jang-Yung Lee Senior Counselor to the Deputy...
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Transcript of Korea’s Financial Reform: A Systemic Risk Approach Jang-Yung Lee Senior Counselor to the Deputy...
Korea’s Financial Reform: A Systemic Risk Approach
Jang-Yung Lee
Senior Counselor to the Deputy Prime Minister
Ministry of Finance and Economy
Republic of Korea
November 2002
Korea’s Financial Reform : A Systemic Risk Approach
• Overall Assessment of Reforms
• Financial Restructuring: Banking vs. Non-banking financial sector
• Corporate sector vulnerability
• Conclusion : Remaining reform agenda
2
Questions to be answered
• What are the lessons to be drawn from Korea’s post-crisis reforms?
• Were the sequence and pace of the reforms appropriate?
• Were Korea’s reform strategy properly formulated to deal with the systemic risks?
• How serious is the systemic threat currently posed by weak corporate sector?
3
Initial policy responses
• Liquidity support by the BOK• A blanket guarantee for depositors• Institutional Infrastructure: => FSC, KDIC, KAMCO• Resolution strategy consulted with IMF and
IBRD• Socio-political consensus on financial reforms
and fiscal support plan
4
A Systemic Risk Approach
• Prioritize the government-led restructuring of financial institutions, based on their systemic importance
• Deposit-taking intermediaries first:
=>a greater risk to the payment system
• Prioritize the banks with the greatest systemic importance
5
Resolution of weak banks
• Two large commercial banks: Jan.’98
• Five small banks: July.’98
• Remaining seven undercapitalized banks: Jan.’99-Sep.’99
• Various forms of restructuring in the banks that were not undercapitalized
6
Speed of banking sector restructuring
• Swift move to recapitalize: meet the 6% CAR by Mar.’99, and 8% CAR by Mar.’00
• Adhered to the tighter CAR even when the banking system returns to normalcy
• Prompt mobilization and injection of the public funds: W 137.5 trillion
7
Use of Public Funds in Financial Restructuring
Re
Capitalization
Deposit Repayment
Asset
Buy
NPL
Buy
Total
Amount Total
Banks 44.3 - 13.2 24.0 81.581.5 59.3
Non-banks
Securities& ITCs
Insurance Companies
Merchant Banks
Mutual Savings
Credit Unions
Sub Total
7.7
10.4
2.7
0.05
-
20.9
0.01
-
12.2
5.8
2.0
20.0
-
0.4
–
0.5
–
0.9
-
0.4
–
0.5
–
0.9
16.0
12.6
16.5
6.6
2.0
53.7
11.5
9.2
12.0
4.8
1.5
39.0
Offshore Institutions - - - 2.3 2.3 1.7
Total 65.2 20.0 14.1 38.2 137.5 100
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Restructuring of non-banking financial sector
• Priority given to the closure of 17 merchant bank sector: large exposure to FX risk
• A tightening of investment guidelines for insurance companies
• Relatively lax supervisory framework for investment trust companies(ITC), even though the weakest among the non-banks
=> posed the significant systemic risk
9
Asymmetric Restructuring
• Regulatory forbearance for the non-bank financial institutions
• Exceptional growth of ITC’s trust assets: July ’98- August ’99
<= Driven by a sharp fall in interest rates + by the lax supervisory oversight
• Continued to be used as a financing vehicle by the large companies => reduced the pressure on corporate sector restructuring
10
Figure 1. Trust Assets of Investment Trust Companies
(Unit: W100 billion)
0
500
1,000
1,500
2,000
2,500
3,000
9701 9703 9705 9707 9709 9711 9801 9803 9805 9807 9809 9811 9901 9903 9905 9907 9909 9911
Stock-type Bond-type Total
11
ITC’s liquidity problems
• Triggered by Daewoo’s debt servicing problems in mid-1999: held 80% of Daewoo’s domestic bonds
• Public confidence further damaged by illegal marketing practices, poor accounting standards, and maturity mismatch
• Redemption pressure increased
12
Stabilization of ITC industry
• Restrict ITC fund redemption: could receive only 50% of Daewoo portion of their investment if withdrawn before Nov.’99
• Create bond market stabilization fund• Public bail-out of two largest ITCs• Intervention justifiable based on the market’s f
ailure to respond appropriately• Systemic risk: event risk or refinancing risk
13
Corporate Sector Restructuring
• Pursued simultaneous restructuring of the financial and corporate sector
• Slow pace of corporate restructuring, due to weakened reform momentum in early 2000
• Weak accounting and disclosure standards• Poor risk management in both firms and banks• Inadequate legal and judicial framework for
court-supervised insolvency procedures
14
Macroeconomic vulnerability
• Smooth macroeconomic adjustment• Success of IMF-supported stabilization
program-> external position no longer a systemic threat by early 1999
• Evidence of reduced vulnerability: no exchange rate misalignment, balance between foreign exchange reserves and domestic money, and normal rate of credit growth
15
Figure 2. Credit Ratings of Korean Firms (Share by the Ratings)
(Unit: percentage)
35.2
27.2
22.9 22.5
27.7
20
41.8
39.638.8
33.1
30.8
37.535.8
39.3
44.8
20
30
40
50
1997.12 1998.12 1999.12 2000.12 2001.1
%
A Grade BBB Grade Speculative Grade
16
Renewed credit crunch in the last quarter of 2000
• Collapse in corporate bond market-> increased refinancing risk
• Heavy concentration of maturing corporate bonds in early 2001 (W 65 tril. 13 % of GDP)
• Demise of merchant banks and shrinkage of ITC as the main investors
• Absence of active high-yield (junk bond) market• Perception of high credit risk -> almost 70 % of m
aturing corporate bond not renewable
17
Quick underwriting scheme
• Primary CBO market to facilitate the revolving of the sub-investment grade bonds
• Let the KDB underwrite 80% of the maturing corporate bonds with sub-inv. grade
• WTO issue: no specificity => non-actionable subsidies
• Assistance strictly limited to economically viable companies: importance of solvency analysis by the main creditor bank
• Penalty rate (260 bp) to avoid moral hazard
18
After the quick underwriting scheme
• Market sentiment improved-> Bond market ceased to be a systemic concern
• Liquidity pressure not likely• =>Absorptive capacity of the primary CBO
(W 6.0 tril.) large enough to deal with the maturing sub-investment grade bonds (W 5.3 tril.)
19
Corporate vulnerability
• Profitability still constrained by large debt burden• Recessionary shock will lead to further strains • 29 % of manufacturing companies have an ICR of less t
han one• Chronically insolvent companies (ICR of less than one f
or three consecutive yrs): 4 % of Korean companies• Total liabilities issued: W 10 trillion, only 2.7 % of ban
king system’s asset• Do not pose a systemic threat to the rest of the economy
=> calls for acceleration of corporate restructuring
20
Remaining challenges
• Orderly exit of the insolvent firms• Need insolvency reform to harmonize three
bankruptcy-related laws • Make the Constant Restructuring System work more
forcefully => Early privatization of the nationalized banks => Promote active M&A market; => Strengthen corporate governance; => More rigorous bank accounting standards;
21
Table 1. Public Funds Injected (Nov.1997~Jun.2002)
Support type
SourcesRecapitalize
Loss
Cover
Deposit
Repay
Asset
Buy
NPL
DisposeTotal
Bond issuance 42.2 15.2 20.0 4.2 20.5 102.1
Recovered funds 3.9 1.2 6.0 4.4 16.7 32.2
Other fiscal resources 14.1 - 0.5 6.3 1.5 22.4
Total 60.2 16.4 26.5 14.9 38.7 156.7
Source : Ministry of Finance and Economy, Public Fund Management Committee(August 2002), White Paper on Public Fund Management
22
Table 2. Estimate of Recollectable Fund (unit: tril.KRW)
Recollection (B)Spent (A) Recollection Ratio (B/A)
TotalSpent
156
Already recollected(’02.3) : 42
FiscalA/C
-Subordinate Debt value held by gov’t (100% recollectable) : 6.4-Book-value of equity-stake at Specialized banks : 10.3 (KDB, KEXIM, IBK)-Sub total : 16.7
-Sale of equity-stake : 13.1~18.4 -Bankrupt asset sales : 3.1~ 3.3-Sale of NPLS : 7.8~10.3
-Sub total : 28.0(24.0~32.0)
KDIC.
KAMCO
Recollectable in Future : 45(41~49)1)
Total Recollection : 87
Non Recollectable(A-B) : 69
26.1%+31.2%
26.9%
55.6%
+ +
1) Present discounted
23
Table 3. Closures and Mergers of FIs (1997-2002)
Number of Institutions as of end of 1997(A)
RestructuredNewly
established
End of
Mar. 2002Exit Merger
Banks 33 5 9 1 20
Securities 36 6 2 16 44
Insurance 50 9 6 9 44
Others 1) 1,982 447 136 32 1,431
Total 2,101 467 153 58 1,539
Note: 1) Merchant Banks, Investment Trust Funds, Mutual Funds, Credit Unions, Lease companies, etc.
Sources : Financial Supervisory Service(FSS)
24
Figure 3. Bank Restructuring flow
BIS Capital Ratio>8%13 Banks
SB/KFB
Rehabilitation PlanDiagnostic Review
Diagnostic Review
Rehabilitation Plan
Disapproved
Approved
Resolution
P&A
M&A
SoundBanks
Dispose NPLs
Recapitalize
Asset Assessment
Lead Manager
Bidding Privatize
BIS Capital Ratio<8%12 Problem Banks
PublicResources
Evaluation
25