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CIAO DATE: 2/00
Update on the Restructuring in Korea
Conference on Crisis & Credit: Restructuring Asia’s Financial Sector Asia Society
October 1, 1999, New York
Distinguished Guests, Ladies and Gentlemen:
It is my honor and privilege to be here and share with you the accomplishments and aspirations of the Korean economy. I would also like to express my special gratitude to Asia Society and President Nicholas Platt who made this conference possible.
Today, I would like to share with you our experience in crisis management and the current progress in restructuring. Many were surprised by Korea’s remarkable recovery after such a severe crisis. As Dr. Joseph Stiglitz, the Senior Vice President of the World Bank and a respected economist, had recently asserted, Korea has become one of the best examples of successful reform.
In the beginning, the crisis had threatened almost all Korean corporates and financial institutions with bankruptcy. The systemic risk at the time was so immense that Korea had to take drastic actions to avoid its total collapse. In a free market economy, market mechanisms should in principle be entrusted. However, the market mechanism in Korea did not function during the period of shock, immediately following the crisis. Hence, reforms were pressing and the Government had to step in, on the condition that its intervention would cease as soon as stability was restored in the market.
The new administration had begun restructuring the financial system. In accordance to the BIS capital adequacy standards, the resolution plans for nonviable financial institutions were developed. Undercapitalized banks were required to submit their management rehabilitation plan. The plans were evaluated by an appraisal committee comprised of local and foreign experts. For financial institutions that were judged to be non-viable, or too costly to restructure after the diagnostic reviews, only resolution was the answer. For viable institutions, on the other hand, the Government provided fiscal support, on a condition that they make substantial efforts to carry out their comprehensive self-rescue plans.
Altogether, the Government had to raise 72 trillion won of public funds, including 8 trillion won for the state-owned specialized banks. This was equivalent to about 60 billion U.S. dollars. It was a bold move because, as far as I know, there is no country in the world that had ever decided to spend 17 percent of its GDP within six months of a crisis.
As a result, the number of commercial banks in Korea has fallen from 27 to 17. The number of bank employees was cut by one third, and the number of branches by 20 percent. Efficiency in the bank management has been greatly enhanced, as the over-banking problem was solved. As a result, the pre-provisioning profits of commercial banks in the first half of this year were record high.
Furthermore, semi-annual reports showed that the average return on equity (ROE) of the commercial banks, excluding Korea First Bank and Seoul Bank, was 11.3 percent, whereas the previous years’ earnings showed large losses. So, most of the banks have successfully recapitalized, helped by their capacity to generate increased profits. The Korea Deposit Insurance Corporation injected 17 billion dollars into banks, and the banks themselves have raised their capital by 7 billion dollars from the investors both home and abroad.
Meanwhile, as a way to ensure the soundness and to improve the competitiveness of the financial sector, strategic templates were distributed not only to the banks but also to securities and insurance companies. These templates can be used as software, providing financial institutions with an opportunity to internally assess the real situation up front and help them develop comprehensive strategies for corporate governance, performance based culture, risk management, information technology and MIS, incorporating international best practices.
Also, going beyond the Government’s aim to privatize Korea First Bank and Seoul Bank through foreign strategic investment is providing a benchmark for the Korean banking system by adopting advanced banking practices. Recently, the Government and New Bridge Capital have signed the Terms of Investment on the sale of Korea First Bank. This T.O.I. is the binding agreement on major terms and conditions for the definite contract. The U.S investment firm will take 51 percent of Korea First Bank, and will have the full management control. The Korean Government will protect the downside risk by taking over non-performing loans from the bank and will participate in its upside gain. The final contract is expected in the coming months.
As for negotiations on the sale of Seoul Bank, the Government and HSBC failed to bridge the gap between their stances on the terms and conditions of the sale. Public funds have now been mobilized to improve the bank’s capital adequacy, and a management consignment will be made with professionals from abroad. The Government will ensure independence for the management along with compensation that matches international practice as well as other performance-based incentives.
The guiding concept of the corporate restructuring was that the restructuring process itself has to be wheeled by financial institutions themselves. Hence, in accordance with market principles, it was envisaged from the beginning that non-viable corporates must be resolved through the initiative of their creditor banks. At the same time, workout programs for financially distressed but viable corporates were devised in partnership with creditor institutions and management.
In the labor sector, reform measures have been steadily implemented to increase flexibility in the labor market. It is true that we have encountered many difficulties in introducing massive layoffs as lifetime employment has been taken for granted. In search of a desirable solution, the Tripartite Committee of representatives from labor, management and the Government had been launched. The Committee did play a very important role and was selected by the International Labor Organization as a model of a sound labor-management relationship.
Along with these reforms, bold liberalization policies have been adopted. In order to establish a level playing ground for Korean and foreign businesses alike, the Government replaced Foreign Exchange Control Law with the Foreign Exchange Transaction Law, facilitating foreign currencies and capital to flow in and out of the country with ease. Following the capital market liberalization, the real estate market was also opened to foreign investment. Now, foreigners are welcomed to merge with or acquire Korean companies. Along this line, the Foreign Investment Promotion Law was also enacted.
As a result foreign direct investment in the first eight months of this year posted 7.8 billion dollars, a 90 percent increase from the same period of last year. Korea attaches high value to the role of international investors in supporting the corporate sector restructuring and the capital market deepening. We are now pursuing full integration into the global economy.
It is noticeable that our reform efforts so far have enhanced the operational efficiency and the soundness of corporates and financial institutions. More pronounced is the fact that we have re-gained considerable credibility from abroad. This improvement, together with appropriate macroeconomic measures including fiscal stimulus, has contributed to stabilizing the financial market and speeding up the recovery of our economy.
The unprecedented V-shaped recovery will greatly facilitate our restructuring efforts. During the first half of 1999, Korea’s economic growth recorded a 7.3 percent and it would further level off in the second half. The sizable current account surplus amounting to 40 billion dollars last year and an estimated over 20 billion dollars this year, coupled with active capital inflows from abroad, replenished Korea’s foreign reserves up to 65 billion dollars, from less than 9 billion dollars at the end of 1997. In the meantime, Korea has fully paid back to IMF the emergency loan (SRF) of 13.4 billion dollars ahead of schedule.
Unemployment rate has declined from the peak of 8.6 percent in February to around 6 percent at present. In addition, consumer prices are very stable, showing only 0.7 percent increase. In conclusion, economic activities have been revitalized while inflation has been kept under control.
Many are asking the question—What are the economic forces propelling such a rapid recovery in Korea? Is Korea safe from the threat of a recurrence of crisis?
It is clear that President Kim Dae-jung’s leadership and his strong commitment to democracy and market principles have been crucial to the successful implementation of the reform. Through the President’s envisioning of the reform beyond an immediate crisis resolution, he has not only earned support from wide spectrum of the Korean society, but gained hands of trust from abroad.
Central to the restructuring process was the establishment of an independent organization, which could exercise sufficient authority and achieve the necessary changes while maintaining market stability. In Korea, this role has been played by the newly established Financial Supervisory Commission, which regulates the entire financial sector.
We were not afraid to challenge the myths of “too big to fail” and “banks are immortal” by liquidating a large number of chaebol affiliates and closing down non-viable banks. Such a decisive departure from the past practices sent a clear signal to the market that the Korean Government is committed to the market discipline. This commitment will be enlivened throughout the whole restructuring process now and the future. And just to remind you, the way we are dealing with the Daewoo problem is a clear reflection of our commitment.
Many critics as well as supporters of Korea are warning us that complacency may be prevailing in Korea, and that it could undermine the momentum of reform as the sense of crisis fades. I am aware of these concerns, and I can assure you that the reform process in Korea has already taken on an irreversible course. Let me now review some of the institutional settings of corporate and financial restructuring that will safeguard against the recurrence of a crisis.
To strengthen prudential regulations, supervisory authority is now required to issue ‘prompt corrective actions’ on a mandatory basis for the undercapitalized financial institutions. Mark-to-market accounting has been introduced. Asset classification standards for banks will be further reinforced by incorporating the forward-looking criteria. Furthermore, the current full protection for depositors will be reduced to partial protection to further activate market discipline.
Eventually, financial institutions in Korea cannot depend on the Government. This means that they have to find their own ways to survive in a severely competitive environment. Accordingly, they will have to consolidate their credit review system and improve risk management to preserve asset soundness.
Corporate restructuring is also here to stay. At the initial stage of the corporate restructuring, the Government set forth five principles. They were enhancement of transparency, elimination of cross guarantees and intra-affiliate trading, improvement of financial structure, establishment of core competencies, and enforcing the accountability of major shareholders and management.
To ensure successful implementation of all five principles, we have installed the necessary institutional framework that will in turn help us accomplish the restructuring based on market principles. Like financial institutions, corporations can no longer overlook the need to vigorously pursue profitability while strengthening their financial structures. By so doing, they will make a clear break from the past practice of focusing exclusively on business enlargement or market share. The management style at Korea’s large corporations will undergo fundamental changes, as they will be forced to compete against foreign firms on a level playing field.
Ladies and Gentlemen,
Despite the progress and an irreversible nature of the reform, I must admit that not all prospects are promising. The Daewoo problem is obviously the largest uncertainty facing us. However, as ironic as it may sound, restructuring the Daewoo Group can be a further evidence of the Korean Government’s commitment to the reform, as evaluated by Moody’s Investors Service. Indeed, the chaebol reform constitutes the top economic policy, as once again confirmed by President Kim Dae-jung recently.
There were nervous reactions in the market immediately after the Daewoo’s liquidity problem had surfaced. Stock prices tumbled and the bond market suffered. The initial shock, however, was short-lived. Stability has largely been restored. After the financial restructuring and recapitalization, Korea’s financial system became resilient to corporate distresses. The Government’s swift response had also played a decisive role in calming down market uneasiness.
Korea will resolve the Daewoo problem in a manner that is transparent, fair and responsible, consistent with market principles and global standards. The Government has already reaffirmed that all creditors will be treated fairly according to the established international rules and practices, regardless of their nationalities.
Encouraging signs have already emerged for a speedy and orderly resolution of the Daewoo problems. Daewoo Securities has been spinned off from the Group. Daewoo Heavy, Daewoo Electronics, Daewoo Telecom and other affiliates will soon be separated as well. Workout process including debt-equity swaps and debt reschedulings will be applied to the individually separated companies of the Group, based upon the results of asset and liability assessments currently in the process.
Certainly, there may be bumps on the horizon. But when all stakeholders join their force in the spirit of common interest, I am sure that we will look back on this incidence as a blessing in disguise. The Daewoo shock underscores the importance of effective chaebol reform, which will pave the way for the sustainable growth of Korea toward into the next century.
Ladies and Gentleman,
At the beginning of the Asian crisis, many had pointed toward structural weaknesses, such as lack of transparency, poor and inadequate accounting standards, highly leveraged corporations, and inefficient regulatory systems, as major causes of the crisis. However, I can assure you, at least in Korea, all those stories are now just history. Thank you for your time and attention.
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