The present paper is to provide a comprehensive and
systematic overview of the recent financial system restructuring
in Korea. It also analyzes structural causes of the recent
financial crisis and discusses implications for the future financial
system evolution in Korea.
Korea`s economic crisis has not been entirely unanticipated.
Throughout the 90s, Korea`s economic structure has become
increasingly vulnerable to shocks. The structural vulnerability
came from two sources - external vulnerability and internal
vulnerability, both of which were in principal caused by the
systemic failure of risk allocation mechanisms. External
vulnerability is characterized is characterized by the overly
short-term debt and term-mismatches resulted from the absence
of prudential supervision were clearly signaling possible foreign
exchange liquidity problems.
Internal vulnerability is characterized by highly leveraged
corporate financial structure. the corporate debt to GDP ratio has
been rising substantially throughout the 90s. The excessive
dependence on borrowing mainly to finance risky investments
had not been possible without imprudent and inefficient credit
allocations of the financial sector and distorted incentive
mechanism based on the "too-big-to-fail" argument.
Indeed, major terms of trade shocks hit the economy and
the collapse of export prices in 1996 and 1997 significantly
damaged the corporate sector. A spate of corporate bankruptcies
undermined the financial soundness and destabilized the financial
market. To make matters worse the lack of transparency and
the government policy mishmash aggravated the situation, all of
which being ended up with the financial crisis in Korea.
Given the imperatives for financial reform, the Presidential
Commission prepared a comprehensive reform package to
overhaul the nation`s outmoded financial system into a
Competitive, Convenient and Sound one, which will be driven by
unfettered competition in an open environment under the market
principle. While the recommendations had been faced with
considerable resistance prior to the crisis, in the aftermath of the
financial crisis, most of the recommendations were taken for
implementation under the IMF program. The thirteen financial
reform bills including the Bank of Korea Act and a bill
establishing consolidated financial supervisory system, were
passed at the National Assembly, and laws were amended to
improve financial transparency of corporate firms and labor
market flexibility. There have also been substantial progresses in
capital market and trade liberalization.
So far, at least the policy directions seem to be in the right
track. However, the restructuring process of the financial system
needs to be considerably accelerated. Delays in the resolution of
ailing and insolvent financial institutions and corporate firms are
undermining the effectiveness of financial sector re-capitalization
program. The Bankruptcy related laws need to be streamlined,
and the corporate debt rescheduling should be based on the
autonomous and voluntary decisions of financial institutions. The
prudential supervisory system also needs to be urgently
strengthened. It must be recognized that the more painful and
drastic the reform is, the faster the Korean economy will be able
to return to the normal growth path.