Financial Risks, Stability, and Globalization
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Author(s):
Omotunde Johnson
Published Date:
April 2002
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The paper offers a valid conceptual framework on financial restructuring and fiscal policy. It is good reading not only for our country, Korea, as we are promoting financial restructuring, but also for financial regulators of other nations who can gain valuable lessons about recovering from a crisis.

In this comment, I would like to offer you a firsthand explanation of financial restructuring in Korea and share with you the difficulties we have faced during the restructuring process.

The paper claims that, even in Korea’s case, the financial regulators’ role during the restructuring has been indirect. But this is only partially true, for their role cannot simply be overlooked. The regulators’ role has included taking direct charge of public finance since the onset of the crisis. Let me briefly mention a few such examples:

  • in January 1998, Korea First Bank and Seoul Bank were recapitalized with government-owned stocks;

  • in December 1997, the government purchased the banks’ subordinated bonds with public funds; and

  • in April 1998, the government backed the rollover of foreign currency short-term debt with financial guarantees.

Two special organizations, the Korea Deposit Insurance Corporation and the Korea Asset Management Corporation, oversaw the actual restructuring. However, the basic strategy and key decision-making were jointly in the hands of the Ministry of Finance and Economy and the Financial Supervisory Commission.

The government determined the basic strategy for restructuring, including among other things the size of public funds needed, the target level for the nonperforming loans arrangement, and the main framework of the workout process.

The vice ministers of the Ministry of Finance and Economy, Financial Supervisory Commission, and Ministry of Planning and Budget are ex-officio members of the decision-making management committees of both the Korean Deposit Insurance Corporation and the Korea Asset Management Corporation.

The Välilä paper described the Financial Supervisory Commission as an organization that is independent from the government. But there should be a better understanding of Korea’s unique financial supervisory structure.

The Financial Supervisory Commission, composed mainly of government officials, is the decision-making body over the FSC’s executive arm, the nongovernmental Financial Supervisory Service (FSS). Another body composed of civil servants, the FSC’s Structural Reform Planning Unit, has wholly overseen the restructuring. Having worked in the area of insurance company restructuring for about one year, in the Structural Reform Planning Unit, I can speak from personal experience.

One can conclude that the fiscal role was very important in Korea’s financial restructuring process. If the fiscal authority is interpreted, in the narrow sense, as the budget authority, it is right to argue that the fiscal authority’s role in the restructuring has been limited. But in Korea, the Ministry of Finance and Economy, which recapitulates the financial policies, oversees in part the fiscal functions, such as tax policy and treasury functions, and also directs the general coordination of financial restructuring and public funds.

Now, let me move on to the fiscal situation of Korea. As of the end of 1999, the Korean government’s direct liability was 22.3 percent of GDP and the contingent liability was 16.8 percent of GDP. From the outset of the currency crisis in 1997 until the end of 1999, the national liability rose by 42 trillion won. But restructuring was not the main factor. The main factors for the fiscal deficit were

  • support for unemployment policy: 21.7 trillion won;

  • support for small and medium enterprises: 14.2 trillion won; and

  • issuance of sovereign bonds to increase foreign reserves: 6.6 trillion won.

When considering that Korea’s direct liability, assuming the burden of financial restructuring, is much lower than the OECD average of 69.5 percent, there is no concern over fiscal soundness. Although the contingent liability has risen sharply since the financial crisis of 1997, we don’t expect that it will jeopardize long-term fiscal soundness. The major contingent liabilities are composed of government guarantees for bonds issued by the Korea Deposit Insurance Corporation and Korea Asset Management Corporation.

The potential fiscal burden from restructuring related contingent liabilities is as follows. The arrangement of NPLs by Korea Asset Management Corporation, as indicated in this paper, has reaped profit with the corporation purchasing bond assets from financial institutions with no danger of this being a serious fiscal burden on the government. In the case of the Korea Deposit Insurance Corporation, we admit that a substantial portion of depositor protection loss coverage, amounting to 21 trillion won, or 4.2 percent of GDP, will be a fiscal burden. As for funds used for recapitalization (about 20 trillion won), profit and loss will be determined by the trend in stock prices of banks under the government’s control. But this is not expected to rise to a level of fiscal burden that cannot be tolerated.

The Korean government is aiming to regain fiscal balance by 2003 through tax revenue increases and fiscal consolidation policy. We plan to keep the increase in the budget to two to three percentage points below the current GDP growth rate (see Table 12.4). Since our target for GDP growth during 2001-04 is set at 8 percent, we would aim to limit the rate of budget increase to the 5 to 6 percent range.

Table 12.4.Fiscal Balance-GDP Targets
199920002001200220032004
Target (percent)2.92.62.1-2.51.1-1.50.1-0.30.2-0.6

As I draw to a close, I would like to share with you the difficulties we have faced in carrying out restructuring.

First, in the financial restructuring process, strict restructuring standards as well as market discipline are needed. During the transition period, however, it seems inevitable that regulatory forbearance would be embraced to some extent, such as lenient loan classification and a non-mark-to-market system, generous loan-loss provision requirements, and so on. In this regard, Korea has gradually strengthened the standard for nonperforming loans. Moreover, the investment trust company (ITC) industry restructuring has been postponed until the corporate and banking industry restructuring are close to completed. With the credit crunch induced by the restructuring of the banking industry, the government cannot help but allow some regulatory forbearance for the ITC industry to support financial intermediation. In fact, this restructuring in the ITC industry, which we started in late 1999, is nearing completion. As for the mark-to-market system, it will take effect starting July 2000.

Second, even though there is a need for strict triage and exit of nonviable firms, there is a limit to its aggressive execution. Two reasons lie behind this: (1) there is, of course, a restriction on financial resources, and (2) there is concern over a potential chain reaction due to the interlinkages between the financial and real sectors.

In closing, I would like to thank the author for the interest in Korea’s financial restructuring and for the valuable recommendations. As one must agree, Korea has come a long way from the bleak days of two years ago. We have taken the crisis as an opportunity, employing open market and reform policies. In this regard, we are grateful for the support from the international community, especially the IMF.

There are still bumps on the road to Korea’s establishment of a new financial system that is more competitive and sound. Yet we are confident that we will successfully overcome these challenges. And I am sure that this seminar will be of great help to that endeavor.

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