Although specialized banks can borrow from the government, deposits constitute their main source of funding.

The number (e.g.

In addition, borrowers are likely to assign a lower priority to repaying a loan to an institution that cannot make new loans (like KAMCO) than to a bank from whom they can get new financing. See the article in its original context from. automobiles and Japanese products are expected to pour into Korea.''. Mr. Camdessus said he hoped the loans to South Korea would help stabilize the region. Because South Korea will hold elections on Dec. 18 and Mr. Kim is constitutionally barred from running again, Mr. Camdessus took the unusual step of seeking pledges from South Korea's three presidential candidates that they would honor the agreement.

All rights reserved. Banks preferred customers perceived as safer, such as large conglomerates with good supply of collateral, seriously curtailing credit to SMEs and the trade sector.67 This “flight to quality” behavior of banks and the subsequent shift of short term debt away from small firms has been characterized as the “broad credit channel” (Bernanke, Gertler and Gilchrist (1996)). Now, many of those diversification attempts are failing, and chaebols are falling like dominoes. The capital account had been only partially liberalized, with intermediation through domestic banks favored over foreign direct investment and direct corporate borrowing. These limits were tightened in August 1997 and limit the lending to a single borrower (including guarantees) to 45 percent of the bank’s equity capital for commercial banks, and 150 percent for merchant banks. The M2 multiplier increased significantly in 19961.

The Korean Asset Management Corporation (KAMCO) was in charge of purchasing impaired assets from all financial institutions covered by the deposit guarantee. The scheme provided for full coverage of all insured deposits held by the depositor of the failed bank, not exceeding the amount of W20 million per individual depositor. Korean companies were allowed to borrow abroad in international bond markets for specific purposes—such as investment in export facilities—with prior notification.

South Korea's member of the IMF Board of Governor is Dong Yeon Kim and the alternate Board of Governor is Juyeol Lee.

These funds have been provided through the issuance of bonds by KAMCO and KDIC, budgetary allocations and exchange of asset, and has been channeled to financial institutions by means of four main instruments: (1) purchase of shares, ordinary and preferred, (2) purchases of subordinated debt, (3) purchases of nonperforming loans, and (4) repayment of depositors (see Table 7).

Limits on large exposure and connected lending were excessively generous, which together with the practice of the main bank, facilitated risk concentration. The government targeted W100 trillion worth of troubled loans for immediate disposal, at an estimated market value of about 50 percent of their book value. This should have included monitoring both on- and off- balance sheet risks, setting much lower limits on exposure to a single borrower or related group of borrowers and on connected lending, requiring appropriate management of maturity mismatches between assets and liabilities in foreign exchange. Over time, the reforms were intended to comprise the restructuring of other important financial institutions, strengthening the regulatory and supervisory framework, improving the mechanisms to deal with troubled institutions and managing troubled loans, increasing the transparency of financial sector information, facilitating the entry of new shareholders (including foreigners) into the system, and addressing the weaknesses of the corporate sector. Thus, real interest rates peaked at about 19 percent in January 1998, and subsequently declined gradually to below pre-crisis levels (real interest rates averaged about 8 percent in 1996-1997). Government support for industry was massive, including import protection, fiscal preferences and, most importantly, preferential access to subsidized credit (so-called policy loans).9 The potential for subsidization was large due to the complicated system of interest rate ceilings that prevailed in the 1970s, when real bank interest rates were negative during most of the period. A final evaluation of the Korean strategy in this area will need to wait until KAMCO disposes of its assets, at which point the direct costs of the scheme to the public purse will be known. They are used to finance activities within the chaebol group and have become an increasingly significant source for intermediating chaebol notes and other paper.

South Korea seeks $20B November 21, 1997: 8:57 p.m. Each chaebol was designated a main bank to examine its financial restructuring plans and to set ceilings on working capital. Three-month promissory notes are widely used in Korea as a means of payment among enterprises, especially among SMEs, and hence 35 percent of domestic corporate debt has an average maturity of less than 3 months, and about 70 percent is under a year.

Thus, the level of resources needed to recapitalize banks and to reimburse insured depositors in failed banks will likely amply exceed initial calculations. The United States, the largest shareholder in the I.M.F., played a big role in pushing Seoul to adopt stern reforms. The stock market index sank to a minimum of 351 in December 24, 1997 from the mid-May 800 peak (see Figure 11). On July 31, 1998, two large banks that had received conditional approval (Hanil and Commercial Bank of Korea) announced their merger, which would create a bank with combined assets of W96 trillion.

Weak regulatory and supervisory arrangements allowed banks to incur in excessive risk without building a capital base to withstand shocks. The borrowing cost differential between protected and unprotected industries was about 2-3 percentage points (see Kiwhan and Leipziger, 1997) during 1972-1884, at a time when nominal lending interest rates averaged 16 percent.

The United States and several other nations agreed to provide $20 billion more as a ''second line of defense'' if the initial money from the international organizations proves insufficient. Substantial amounts of capital have been promised from private sources, including from overseas (see Box 1).

Interest rate spreads widened significantly: the spread between lending and deposit rates rose to an average of almost 4 percent during the first half of 1998, from close to 3 ½ percent in 1997; the spread between government bonds and corporate bonds reached 900 basis points in December 1997, compared to about 100 basis points before the crisis; At the same time, the spread between lending rates on overdrafts and yields on corporate bonds soared to about 1300 basis points, affecting mainly the SMEs heavily depending on bank credit (see Figure 6). Thus, its ability to require the bank to undergo a thorough operational restructuring is much more limited. Also, if the bank’s condition improves, KAMCO will not benefit from that, while an owner of the bank’s equity will. The agreement consisted in the exchange of short term debt into government guaranteed transferable loan certificates maturing in one, two and three years at floating interest rates of 2.25, 2.25 and 2.75 over six month LIBOR respectively. ET President Kim Young-sam asks for his country's support for the radical plan Despite the inevitable turmoil of successive waves of bank closures, the public maintained confidence in the Korean banking system. In order to ensure the liquidity of banks, the OBS required that long term loans, defined as those with a maturity between one and ten years, should be financed with funds with maturities of at least a year. As noted earlier, the FSC is responsible for supervising and setting regulatory standards and prudential standards for all financial institutions.54 Regulations are being phased in to bring merchant banks and other financial institutions under the supervisory umbrella and to subject these institutions to the same prudential standards as commercial banks.

This should help slow their expansion. The initial official estimates of the capitalization needs to bring the banking system, under Korean classification and provisioning rules, to the minimum 8 percent capital adequacy ratio, was about Wl 1 trillion, or 2.6 percent of GDP. The main borrowers are SMEs with weak credit-standing and individuals with limited access to formal financial institutions.

In principle, trust account are operated on the client’s own account and not counted when computing a bank’s capital adequacy ratio.

This measure is expected to induce some increase in turnover in the foreign exchange market, one of the lowest among developed countries, and enhance the pricing of the forward market so as to reflect interest rate differentials. A maturity ladder approach will be implemented for commercial banks (January 1, 1999) and merchant banks (July 1, 1999), which will be monitored by FSC on a monthly basis.57 Overseas branches and subsidiaries will be included in the calculations. KaminskyG.LizondoS. Korean commercial banks posted losses of about W4 trillion in 1997 and W67 trillion (about 3 times bank’s total end-1997 capital) in the first half of 1998. Assessment of future repayment capacity or potential problems, related for example, to large exposures to a single group, carried little weight.

Commercial banking is highly concentrated, with the top eight banks accounting for about two-thirds of commercial bank assets (excluding trust accounts).

3 Data for 1997 corresponds to averages of the first two quarters. These loose prudential regulations allowed banks to build in risky portfolios and to report profits and capital adequacy ratios that did not fully reflect their true financial position.

The modification was as follows: If a financial institution defaults before end-2000, the depositors with deposits of more than W20 million will be paid the amount of the principal, whereas depositors with deposits of W20 million or less will receive the principal plus a payment calculated on the basis of market interest rates (rather than the deposit’s contractual interest rate). However, Korean provisioning rules are significantly backward looking, and are therefore likely to underestimate the probability of loan losses in periods of financial distress.

The result was a buildup of huge debts.

Regulations limited international issuance of securities to corporations with international credit rating of BBB or higher, and to obtain loans at spreads higher than 100 over LIBOR. In December 1997, the government took over two large commercial banks, Korea First Bank and Seoul Bank, which were technically insolvent.

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