Country Finance (sample)
Country Finance South Korea 2003
Market assessment--South Korea February 2003
* Consolidation continued in South Korea's commercial banking sector with the
merger of Hana Bank, a solid private financial institution, and Seoulbank, a
venerable but state-owned laggard, in December 2002. This was the most important
tie-up since Kookmin Bank and Housing & Commercial Bank joined forces to
create the largest domestic bank in November 2001 (1.1, 1.3).
* After years of debate, stringent restrictions on ownership of national
commercial banks were eased under an amendment to the Banking Act effective July
28th 2002. The change increased the cap on individual shareholding in a national
commercial bank to 10% from 4%. The ownership cap on regional commercial banks
remained at 15% (1.3).
* The National Tax Service changed reporting rules to make it easier for
international taxpayers to take domestic income out of the country. It abolished
prior notification requirements for remittances abroad from July 2002. At the
same time, it introduced a new measure aimed at preventing international
taxpayers from shopping around for domiciles from which to gain the most
favourable tax-treaty provisions (5.9).
* Small and medium-sized companies have benefited from the South Korean
government's efforts to introduce alternatives to the traditional use of
promissory notes for payments. Several new schemes-including corporate
procurement loans, a credit programme based on receivables and a credit- card
purchasing system-have proliferated in the past few years (see section 7.3 and
the boxed text on page 44).
* Samsung Life Insurance made South Korea's first crossborder mortgage-
backed securitisation when it launched a US$300m deal in December 2002. The
transaction should boost the structured finance market in Korea-in particular by
opening it to international investors (see section 12.4 and the case study box
on page 71).
Market watch
* The government is seeking to sell to the private sector its majority stake
in Chohung Bank, a deal which would change the landscape of the country's
commercial-banking industry. The authorities gave Shinhan Financial Group a
priority right to negotiate the deal in December 2002. They also plan to carry
out sales of a majority stake in Woori Bank and minority stakes in Korea First
and Korea Exchange banks (1.3).
* A new corporate pension scheme modelled on the US 401(k) programme may be
introduced sometime in 2003. The Ministry of Finance and Economy (MOFE) is
anxious to pass the reform as part of its proposals for the country's labour
market, but it still has some ways to go to find a compromise between the needs
of employers and employees (see section 2.2 and the legislative watchlist on
page 32).
* Asset management in South Korea is set to undergo substantial reform in
2003. The government wants to pass legislation to deregulate the industry, with
the aim of creating equity alternatives to bank credit. It also wants to boost
capital markets to help manage financial issues associated with the ageing of
the population (see section 2.4 and the boxed text on page 24).
* In April 2002 the MOFE released a long-term policy blueprint for the
complete liberalisation of South Korea's foreign-exchange regime by 2011.
Incremental changes will address local funding limits, forex permits and
repatriation requirements. In a final stage, new basic legislation will replace
the current Foreign Exchange Transaction Act (see section 5.1 and the
legislative watchlist on page 32).
* The National Assembly passed legislation creating free economic zones for
foreign investment in December 2002. From July 1st 2003 the new law will offer
foreign companies tax holidays and breaks in return for commitments to make
sizeable investments. The first such locations are planned for the Seoul area
(6.5).
South Korea at a glance
Political structure
Elections: Roh Moo-hyun, the candidate of the incumbent Millennium Democratic
Party (MDP), won the December 2002 presidential election and took office on
February 25th 2003. He was directly elected for a single, non-renewable term of
five years. The unicameral National Assembly of no fewer than 200 members
(currently 273) is elected for four-year terms, and the next election is due by
April 2004. Currently, 227 seats are filled by direct election; the remaining 46
are distributed between parties in proportion to their share of the vote.
Government: South Korea's democratic political system places a great deal of
power in the hands of the directly elected president. He appoints cabinet
members and determines the general direction of national policies. The MDP, led
by former President Kim Dae-jung, formed a coalition with the much smaller
United Liberal Democrats (ULD) in 1998, but the ULD left the government in
September 2001.
Major parties: The opposition Grand National Party (GNP) remains the largest
party in the National Assembly, with 136 seats. The MDP has 118 seats, the ULD,
15, and the Democratic People's Party (DPP), 2.
Fiscal year: January 1st-December 31st.
Sovereign debt ratings
Standard & Poor's: A-
Moody's Investors Service: A3
Senior unsecured long-term foreign-currency debt ratings.
EIU country risk rating
Economic Economic
Overall Overall Political policy structure Liquidity
rating score risk risk risk risk
B 28 C A B B
The EIU Country Risk Service provides risk assessments for 100 countries.
Every country is rated by category, ranging from "A" (the lowest risk) to
"E" (the highest risk), and assigned a grade for political risk, economic
policy risk, economic structure risk and liquidity risk. Overall scores
can range from 0 ("A" category) to a maximum of 100 points ("E" category)
for the highest-risk countries. For more information, consult the CRS
Handbook and the CRS report on South Korea for the most recent quarter.
Economic assessment
2001(a) 2002(b) 2003(c)
GDP (W trn at constant 1995 prices) 493.4 521.3 545.5
GDP growth (% change) 3.3 5.7 4.6
Private consumption (% GDP) 59.4 60.9 61.3
Government consumption (% GDP) 10.4 10.5 10.3
Gross fixed investment (% GDP) 27.0 26.6 25.9
Exports of goods & services (% GDP) 43.1 45.1 47.8
Imports of goods & services (% GDP) 40.5 43.2 45.3
Consumer prices (%, av) 4.1 2.8(a) 2.5
Exports fob (US$ bn) 151.4 161.9 176.6
Imports fob (US$ bn) -138.0 -147.9 -163.0
Current-account balance (US$ bn) 8.6 7.2 6.3
Budget balance (% of GDP) 1.3 0.3 0.7
Foreign debt (% of GDP) 28.8 26.8 24.8
Exchange rate (W:US$1, av) 1,291.0 1,249.7(a) 1,191.0
Notes: (a) actual; (b) Economist Intelligence Unit estimates; (c)
Economist Intelligence Unit forecasts.
Source: Economist Intelligence Unit, South Korea Country Forecast,
February 2003.
Executive summary.
South Korean financial institutions have taken great strides in recent years
in transforming themselves into stable, market-oriented financial
intermediaries. Until the economic crisis of the late 1990s, they remained
servants of the country's state-directed development programme, which, while
extremely successful, had eventually outlived its usefulness. The regional
financial crisis spurred a dramatic reorientation by South Korea towards a
free-market economic strategy, and it has enjoyed greater success in this
transformation than any other country in Asia.
Banking reform and consolidation has progressed, notably with the merger of
Kookmin and Housing & Commercial banks in late 2001 and the tie-up of Hana
Bank and Seoulbank in late 2002. Foreign financial interests have been allowed
to acquire majority control of several local banks. The government continues to
divest itself of stakes in local banks, recapitalise other distressed financial
institutions and prop up troubled investment-trust companies. Foreign
competition has intensified, meanwhile, in such areas as investment banking,
insurance and fund management.
Conditions for foreign business have greatly improved in South Korea over the
past several years. Interest rates have fallen below the levels seen before the
financial crisis, and the won, the local currency, has been permitted to float
freely and find its value in the market. Foreign- exchange controls were mostly
abolished in a series of stages concluding at end-2000, and the government has
outlined a plan for the complete liberalisation of the forex regime over the
next decade. Taxation is moderate and public services are good. However, South
Korea continues to face the risk of armed conflict with North Korea and the
possible impact of that country's economic collapse.
The Korea Stock Exchange, once illiquid and subject to manipulation, has
gained in trading volume with the admittance of foreign portfolio investors.
Share prices and new issues recovered after the financial crisis of 1997-98, but
then lost ground in the worldwide economic downturn of 2001-02. A
technology-heavy, Nasdaq-style market, the Kosdaq, has attracted initial public
offerings from smaller, innovative companies. Derivatives products are widely
available over the counter and, to a lesser extent, on the Korea Stock Exchange
and the Korea Futures Exchange.
Bank credit is readily available in short-term maturities but is difficult to
secure for periods of over one year. Funding is typically provided in short-term
increments and rolled over at frequent intervals. Money-market instruments,
equity sales and bond issues are all well-established financing techniques for
domestic companies but are still little used by foreign enterprises. The lifting
of capital controls in recent years has made it much easier for foreign-owned
operations to finance themselves from outside the country.
Financial institutions - 1.0 Banks - 1.1 General.
The foundations of South Korea's financial system were laid in the early
1950s when the central and commercial banking systems were established under the
Bank of Korea Act and the Banking Act. Development and specialised banks were
created in the 1960s, so that state distribution of capital could meet the needs
of economic development. Most non-bank financial institutions were created
during the 1970s in order to diversify financing sources and develop the money
market. From the early 1980s, several commercial banks and non-bank financial
institutions were added as part of the country's first steps towards financial
liberalisation and internationalisation. This coincided with a slow move away
from state control over the financial sector.
The economic crisis that struck the country in 1997-98 has led to some very
positive changes. In the private sector, the fragmented financial sector has
undergone a great deal of consolidation and competitive realignment. According
to the Financial Supervisory Commission (FSC-1.2), a total of 630 out of the
2,068 financial institutions at end-1997 had been closed down by mid-2002 under
the government-driven restructuring. They included 14 commercial banks, 28
merchant banking corporations, 16 securities firms, 15 insurers, eight
investment-trust management companies, 126 mutual savings banks, 423 credit
unions and ten leasing companies.
The authorities, in the meantime, have been pushing a programme of reforms
designed to equip the country with a financial system similar to those in the
most developed markets. In the new environment, financial institutions have much
greater freedom of activity, but face stiffer competition, including
unprecedented rivalry from overseas. Foreign banks have since acquired control
of two leading national commercial banks.
At end-June 2002 the number of domestic financial institutions stood at
1,510, including 20 banks and thousands of non-bank institutions (including
three merchant banks, 44 securities firms, 44 insurers, 31 investment-trust
management companies, 19 leasing companies and nine credit-card issuers). The
non-bank financial sector also includes many mutual savings banks, credit
unions, community credit co-operatives, a postal savings and insurance network,
and instalment-credit and venture capital companies.
The overall importance of banks in the financial system has increased in
recent years amid a broad shift of financial assets to banks and away from
non-bank institutions that the public considers less stable and safe. A change
in regulatory practices caused this structural shift. For years non-bank
financial institutions were given greater freedom in their operations and
allowed to offer higher interest rates on their deposits and loans than banks.
However, the interest-rate gap is narrowing, if not disappearing, because of the
liberalisation of interest rates (3.1). Non- bank institutions, unlike banks, do
not have to meet special limits on ownership, and some are affiliated with banks
and securities companies.
At end-June 2002 the banking sector comprised 15 commercial banks (including
Seoulbank, which merged with Hana Bank in December 2002), three specialised
banks (Industrial Bank of Korea, the National Agricultural Co- operative
Federation and the National Federation of Fisheries Co- operatives), and two
development institutions (Korea Development Bank and Export-Import Bank of
Korea).
There have been many recent changes in the line-up of South Korean banks.
Five commercial banks were ordered to close down in June 1998, after the FSC
decided they were not viable. Six national commercial banks merged into three
larger banks in January 1999, and another was sold to a US investment group in
December 2000. There were two major bank mergers in 2001: Kookmin and Housing
and Commercial combined operations to form the country's largest commercial
bank, and Hanvit and Peace Bank of Korea merged to create Woori Bank, the second
in rank. Finally, Hana Bank and Seoulbank combined operations in December 2002,
marking an end to Seoulbank, one of the oldest commercial banks.
The onset of the financial crisis of 1997-98 owed much to the system of
directed lending and the close relationship that existed between corporations
and the banking sector. Government-directed lending and state-regulated rates
fuelled staggering economic growth for decades leading up to the crisis, but at
a price: nepotistic lending patterns, poor regulation and disclosure, and a
mountain of questionable loans that could barely be calibrated because of poor
accounting transparency. Ambitious investment decisions were subject to scrutiny
only by bank managers, whose appointment was traditionally influenced by
government bureaucrats.
During the period of high economic growth, such a model worked superbly. A
change came in 1997 when family-run conglomerates, the chaebol, began to
collapse in a sharp economic downturn. The Asian financial turmoil, touched off
by a Thai currency devaluation in mid-1997, turned South Korea's situation,
which still looked manageable, into a catastrophe when foreign capital was
sucked from the country's economic system all at once. More companies collapsed,
unleashing a deluge of bad debt.
South Korea recovered rapidly from the crisis and has solidified its
financial system through injections of public funds. The government injected
W157.1trn in fiscal support for financial-sector reforms between late 1997 and
October 2002. The massive mobilisation of public funds was aimed at shoring up
the shaky finances of local banks, cleaning up bad debts and paying for deposits
on behalf of failed financial institutions. The total count of non-performing
loans (NPLs-overdue for more than three months) in the entire financial system
had declined to W34.7trn, or 4.3% of total loans, by end-September 2002, from
W88trn, or 14.9%, at end-1999, according to the FSC. NPLs held by the banking
sector (including domestic commercial, mutual and foreign banks) stood at W15trn
at end-September 2002, or 2.4% of total bank loans.
Many financial institutions have launched a transition to rule-based
competitive operations. The concept of risk has totally changed, and financial
institutions have begun to correct their traditional focus on lending to big
corporate clients without considering credit risk. They are also cutting down on
long-term exposure to corporate borrowers as part of an effort to maintain or
improve their asset quality. Some are re- configuring their operations towards
lower-risk and higher-margin retail customers, and diversifying services to
accommodate retail demand. At the same time they will be required to acquire
more sophisticated credit- analysis techniques to retain existing customers and
attract new ones. Such techniques are underdeveloped in South Korea, as service
providers have tended to resort to collateral rather than objective credit data.
Many financial institutions are seeking to emphasise their specialities as
the financial system moves away from a heavily regulated and closed environment
and towards a more liberal and open market. Regional banks, for example, which
had competed with national commercial banks for corporate clientele, are seeking
to specialise in retail banking by serving households and the small business
sector, with a limited geographic coverage. In the securities industry, some
small and medium- sized brokerages are finding niches in online trading,
financial futures, bond underwriting and other areas in which they can build
core competence.
Financial market indicators for South Korea
Financial market indicators for South Korea
Demand for financial services
Population, mid-2001(1) (m) 48.06
Age 65 and above (%) 7.57
Between ages 15-64 (%) 70.78
Under 15 (%) 20.85
Gross domestic product, 2001(1) (US$ bn) 464.78
Gross domestic savings, 2001(1) (US$ bn) 130.60
Gross domestic product per person, 2001(1) (US$) 9,670
Personal disposable income per person, 2001(1) (US$) 6,492
Private consumption per person, 2001(1) (US$) 5,890
Financial intermediaries
Domestic credit outstanding by the banking sector, 2001(2) (% of 110.37
GDP)
Domestic credit to the private sector, 2001(2) (% of GDP) 108.03
Insurance company premiums, 2001(3) (% of GDP) 11.96
of which life insurers, 2001(3) (% of GDP) 8.61
National Pension Corporation assets, end-November 2002(4) (% of 15.69
GDP)
Investment-trust management company assets, end-2002(5) (% of GDP) 28.79
Venture-capital investment, 2002(6) (% of GDP) 0.10
Factoring company turnover, 2001(7) (% of GDP) 0.02
Financial leasing assets, end-June 2002(8) (% of GDP) 0.96
Capital markets
Equity market capitalisation of shares of domestic companies, end- 46.45
2002(9) (% of GDP)
New equity capital raised by domestic companies, 2001(9) (% of GDP) 0.96
Domestic corporate debt market issues outstanding, end-June 56.41
2002(10) (% of GDP)
International corporate debt market issues outstanding, end-June 9.27
2002(10) (% of GDP)
Sources: (1) Economist Intelligence Unit, Country Indicators; (2) World
Bank, World Development Indicators; (3) Swiss Re, Sigma 6/2002; (4)
Ministry of Health and Welfare; (5) Korea Investment Trust Companies
Association; (6) Small and Medium Business Administration; (7) Factors
Chain International; (8) Financial Supervisory Commission; (9)
International Federation of Stock Exchanges; (10) Bank for International
Settlements, Quarterly Review on International Banking and Financial
Market Development.
Financial liberalisation and deregulation are fuelling this shift, with more
liberal laws replacing strict financial codes (1.2, 5.1). For instance, in April
1999 the new Foreign Exchange Transaction Act, which liberalised virtually all
kinds of current- and capital-account transactions, replaced the Foreign
Exchange Control Act, which put many restrictions on crossborder capital flows.
Foreign and domestic financial institutions seeking to enter the market face
easier and more transparent rules. Foreign fund managers are no longer required
to have a local joint venture to set up operations in the country, and foreign
and domestic securities companies are now allowed to establish brokerage-only
"boutique" subsidiaries.
Another systemic change underway is the consolidation of financial
institutions. Many non-viable institutions have already been shut out of the
market, with the surviving ones scrambling for tie-ups. In the banking sector,
consolidation is seen by both regulators and banks as a matter of long-term
survival, and the sense of urgency is driving some banks into voluntary
mergers-a rare phenomenon in South Korea's closed corporate culture and given
the prevalence of militant labour unions. In November 2001 the country's
largest-ever banking merger brought together Kookmin Bank and Housing &
Commercial Bank. In December 2002 another major merger combined the operations
of Hana Bank and Seoulbank.
Despite the collapse of several deals in 2001 and 2002, both the government
and local financial institutions are keen to promote strategic alliances and
equity partnerships with foreign firms. Many foreign financial institutions
seeking to build local market share still prefer joint venture and acquisition
strategies to the establishment of independent operations. Most South Korean
banks have foreign partners with substantial equity holdings: Kookmin Bank with
Goldman Sachs (US, 5.4%) and ING Group (Netherlands, 4%); Korea First Bank with
Newbridge Capital (US, 51%); Korea Exchange Bank with Commerzbank (Germany,
23.6%); KorAm Bank with the Carlyle Group (US, 40.1%); and Hana Bank (including
Seoulbank, which it absorbed in December 2002) with the Allianz Group (Germany,
11.8%).
Of all financial institutions, deposit banks-national and regional commercial
banks, specialised banks and foreign bank branches-are the most important
sources of credit for companies. National commercial banks have adopted a branch
banking system throughout the country, with their headquarters in the capital,
Seoul. Regional banks based in major cities outside Seoul have adopted branch
banking within a province. They are allowed to place up to ten branches in Seoul
and up to two in each of six major provincial cities that are not home to their
own head office. The number of domestic bank branches reached 6,259 at end-June
2002.
Meanwhile, foreign bank branches, mostly located in Seoul, have tended to
specialise in the wholesale banking business, although Citibank (US) and HSBC
(UK) have been pushing into retail competition aggressively in recent years.
There were 42 foreign banks in operation at end-September 2002.
1.2 Bank regulators.
The Ministry of Finance and Economy (MOFE) and the Bank of Korea (BOK-the
central bank) were long the two pillars of the South Korean financial system.
However, in reality, it was the MOFE that called the shots for all the important
decisions. That changed somewhat in the wake of the 1997-98 financial crisis,
which left a mark of shame on the MOFE.
From December 1997 a series of legislative moves were taken to delegate the
powers of the MOFE to the central bank and new economic super- agencies,
including the Financial Supervisory Commission (FSC) and the Planning and Budget
Commission (later renamed the Ministry of Planning and Budget). The FSC gained,
and the MOFE lost, the power to authorise the establishment and closure of
financial institutions in May 1999. As a result, the official function of the
MOFE is now restricted to macroeconomic management, although its unofficial
influence remains pervasive. Many senior staff at the FSC were trained and built
their careers at the MOFE.
The MOFE has recently recovered some of its authority. Under a new government
re-organisation law enacted in December 2000 and put into force in January 2001,
the minister of finance and economy was reinstated as deputy prime minister to
co-ordinate economic policymaking across several economic agencies, including
the FSC. For information on each of these bodies, see the key financial contacts
list on page 74
The MOFE's decisive edge over the FSC is its power to write financial laws.
The crisis experience has imbued the MOFE with some respect for market
principles, as the ministry seems to regard deregulation more seriously than it
did before. But critics point out that its meddling with financial institutions
continues and has only become more sophisticated.
The BOK continues to act as the bank for commercial banks and the government,
but its banking supervisory functions were handed over to the FSC in April 1998.
The BOK is now responsible only for control of inflation and for executing
monetary and credit policy (3.1, 3.2).
The central bank governor, appointed by the president on the recommendation
of the cabinet for a renewable four-year term, chairs the policy-making
seven-member Monetary Policy Committee. This means that the BOK is now
officially free from the influence of the MOFE. The BOK has 12 departments in
its head office in Seoul and 16 branches in major cities throughout the country.
In addition, it has five overseas representative offices in principal
international financial centres.
The increasingly powerful FSC now holds the power for day-to-day policy
decisions for the financial industry. It defines its role as a
"controller" rather than a "supervisor" as it handles the
tough task of reinventing the South Korean financial system. The FSC also
controls the Securities and Futures Commission (SFC), which is similar to the US
Securities and Exchange Commission.
The official status of the FSC is as the governing body of the Financial
Supervisory Service (FSS), created in January 1999 to bring all financial
regulators under the same roof. By law, the FSC comes under the jurisdiction of
the prime minister, but in practice it is an independent agency. The FSS
consists of the former operations of the Banking Supervisory Authority (BSA),
the Securities Supervisory Board (SSB), the Insurance Supervisory Board (ISB)
and the Non-bank Supervisory Authority (NSA). Its responsibility ranges from
authorisation and supervision to examination and enforcement.
The government revised the Act on Structural Improvement of the Financial
Industry in September 1998 to speed up banking mergers and private-sector
recapitalisation. This legislation also provided legal grounds for prompt
corrective action (PCA) procedures, including a complete write-down of
shareholder capital. Restrictions on mergers between financial institutions with
combined market share of more than 30% were also lifted.
The FSC enacted financial-services industry guidelines in July 1999 with the
aim of bringing local regulations in line with international standards, making
authorisation and approval procedures transparent, and promoting sound
competition. In the past, such guidelines existed only for certain sectors,
including banking, insurance, securities and fund management operations, with
the rest subject to the government's arbitrary rulings.
All new applications for financial services licenses and the FSC's reviews of
them are now published on the Internet and through other media. The guidelines
stipulate rules on new business entry, mergers and acquisitions, liquidation,
and cross-sector operations. At the same time, the FSC set the criteria for
approval of the business plans submitted by new entrants, which should spell out
how they intend to achieve and maintain adequate capitalisation, revenue flows,
sound financing and risk management, proper corporate governance, and sales and
back-office infrastructure.
Approval criteria for a new financial institution include tougher
financial-soundness requirements for major shareholders. Minimum capitalisation
requirements have been set at W100bn for a national commercial bank; W50bn for a
"supermarket" full-service securities business, W10bn for an
investment-trust management company, W30bn for an insurer, W30bn for a
merchant-banking corporation and W20bn-40bn for a credit-card company. Major
shareholders of a non-viable financial institution cannot enter into new
business in the financial sector, unless they fulfil their liabilities arising
from the earlier failure.
Under the Banking Act, a banking license is required to conduct traditional
lines of banking business and some non-banking activities. These include
underwriting, dealing and sale of government bonds; sale of trust accounts and
management of assets under trust contracts; credit-card operations; factoring
and futures transactions; and issuance of asset- backed securities. Since
business demarcation is very strict, commercial banks can engage only in very
limited securities business and are not allowed to engage in the insurance
business.
The financial crisis of 1997-98 and subsequent liberalisation have given
foreign financial institutions increased freedom to do business in South Korea.
Foreign financial institutions must be licensed in their home countries to
operate in the same type of business in South Korea. From January 1998 greater
foreign ownership of local commercial banks has been allowed, but official
approval is still needed when stakes top 10%, 25% and 33%, successively.
Approval is almost automatic for established global banks. From April 1998
foreign banks and securities companies have been allowed to establish
subsidiaries in the country. Foreign companies are subject to the same
market-entry guidelines that apply to local banks and securities firms.
The FSC issued a set of guidelines, effective January 17th 2000, for
cross-sector alliances among different types of financial-services providers.
All financial institutions are allowed to outsource non-core operations to other
entities in different sectors. Previously, such outsourcing arrangements were
only allowed between banks and consumer- credit providers with prior official
approval. These "non-essential" operations include
automatic-teller-machine operations, credit research and management, credit-card
membership sales, securities custodial services, insurance product development,
and actuarial services. Leading commercial banks, with their extensive client
bases, stand to benefit most from this liberalisation.
The FSC has borrowed lessons from the US savings-and-loan debacle in the
1980s for the ongoing clean-up process of non-viable financial institutions.
Prompt corrective action (PCA), introduced in June 1998, is one decisive weapon
with which the FSC enforces directives on banks and other financial institutions
(including insurers, securities companies, asset-management companies, mutual
savings banks and credit unions) deemed non-viable or financially weak. PCA is
typically triggered by a fall in asset quality and solvency margin performance.
PCA measures range from requests for turnaround plans to mergers to business
closures. Forced asset sales and outright liquidations are other possible
actions.
The FSC placed seven commercial banks under the PCA programme between 1997
and 2000 for failing to meet the Bank for International Settlements' minimum
capital-adequacy ratio of 8% (6% for regional banks). By December 2002, however,
all of them had graduated from the programme.
The FSC conducts a quarterly "CAMELS" (capital adequacy, asset
quality, management, earnings, liquidity and sensitivity to market) survey of
banks to make sure they meet adequacy requirements. It is also using a more
sophisticated "early warning" system as an econometric model of asset-
quality surveillance. It can order PCA by banks that fail to meet operating
standards and can restrict a bank's business if such action is in the best
interests of depositors or of the stability of the financial system. In July
2001 the FSC strengthened disclosure rules, requiring banks to disclose net
interest margins and productivity per employee and per branch in their financial
statements.
The CAMELS survey also applies to non-banking institutions. Since April 2000
the FSC has required weak securities companies and insurers to submit
"commitment letters" or "memoranda of understanding" for
management improvement. Disclosure by insurers now has to be made on a quarterly
basis, instead of semi-annually as before. The agency increasingly targets what
has been the most unregulated sector, by tightening control over insurance
companies, merchant banking corporations, securities and fund- management
companies, and other non-bank institutions, and by changing various laws and
regulations. Many of these moves are aimed at preventing the chaebol and smaller
companies from using non-bank institutions with direct and indirect financial
connections as private money pipelines.
The FSC has also strengthened accounting and disclosure requirements for
financial institutions, which must now abide by accounting standards that are
fully consistent with the US's generally accepted accounting principles (GAAP).
For instance, they must account for marketable securities holdings at market
prices and disclose details of large bad loans and significant "financial
accidents". Banks in particular are required to issue quarterly financial
statements within three months after closing their books. From 1998 large
financial institutions, including commercial banks, have also been required to
receive audits on their financial statements by one of the major global
accounting companies.
Furthermore, the FSC has put in place tougher loan-classification guidelines.
The definition of "non-performing loans" (NPLs) was expanded to those
not serviced for three months or longer (from a previous six months) in July
1998. Loans came to be classified as "precautionary" if not serviced
for between one and three months (from a previous three to six months). Loans
not serviced for 12 months or longer must appear as losses on balance sheets.
Commercial banks and other financial institutions have had to adopt
"forward-looking criteria" in assessing credit risk and setting aside
loan-loss provisions. They must examine future cash flows as a determining
factor of the credit risk of a particular borrower and set aside provisions up
to certain percentages of outstanding loans based on the revised credit
evaluation criteria (0.5% for "normal" loans; 2% for
"precautionary" loans; 2-20% for "restructured" loans;
20-50% for loans not serviced for at least three months; 50-100% for loans not
serviced for at least three months and looking unrecoverable; and 100% for loans
not serviced for one year or longer). The forward-looking criteria effectively
expanded the definition of NPLs, which should include "questionable"
loans-that is, normal loans that look likely to become non-performing in light
of changed financial circumstances of the borrower.
A set of revised loan classification rules took effect at the beginning of
2000, with certain limits placed on "credit allowances" as opposed to
"loans and fixed payment guarantees". This makes all direct and
indirect financial transactions involving credit risk subject to the FSC's
prudential guidance. The rules apply to all financial institutions. For example,
a private placement of notes to a bank and a purchase of accounts receivable
must be included in the credit allowances subject to official limits. Since
January 2003 even corporate bonds acquired from a public offering and held for
investment purposes have been included. Specifically, banks must operate under
the following credit policies:
* Credit allowances to the same conglomerate (connected lending) cannot
exceed 25% of the lender's equity capital;
* Credit allowances to the same individual or company cannot exceed 20% of
the lender's equity capital;
* Credit allowances to the same individual, company or conglomerate exceeding
10% of the lender's equity capital cannot be in excess of five times its equity
capital when all such large exposures are combined;
* Credit allowances to the major shareholder of a lending institution cannot
exceed 25% of the institution's equity capital;
* Credit allowances to a single subsidiary of a lending institution cannot
exceed 10% of the institution's equity capital; and
* Credit allowances to all subsidiaries combined cannot exceed 20% of its
equity capital.
In October 2000 the FSC began monitoring credit allowances extended to large
corporate borrowers (with a total balance of W50bn or more) and those affiliated
with business groups (with a group-wide credit balance of W250bn or more). Any
sharp increase in the outstanding balance of credit allowances is seen as a
warning sign triggering an asset quality watch of the creditor bank or other
financial institutions owned by the borrower.
Banks are required to make at least a certain amount of lending capital
available to small and medium-sized companies (generally defined as companies
with fewer than 300 regular employees). National commercial banks must extend
45% of new loans to small and medium-sized companies; provincial banks are
supposed to extend 60%. Foreign banks must give such firms 25% of new loans.
The FSC has recently shifted its focus from corporate debts to consumer debts
in light of a surge in the latter (including credit-card loans from companies
affiliated with commercial banks) that began in 2002. According to the Bank of
Korea (BOK-1.2), financial liabilities held by South Korean households as a
percentage of GDP increased to 72.9% at end-June 2002, from 64.8% at end-2001
and 56.2% at end-2000. By comparison, in the US such liabilities stood at 78.7%
of GDP at end-2001. A BOK survey of banking lending practices showed that the
share of personal loans in total won-denominated bank loans increased to 54.4%
in end-September 2002, from 34.4% at end-September 1997.
The FSC told commercial banks to increase loan-loss provisions against
defaults on consumer loans (effective from the second quarter of 2002) and to
increase risk weightings on mortgage loans (effective from November 2002). It
also instructed banks to cap loan-to-value ratios on mortgage loans at 70% and
to raise personal credit rating standards for mortgage lending.
Some private industry organisations act as unofficial government agents in
regulating member institutions, and regulators defend this practice as giving
more autonomy to the private sector. The Korea Federation of Banks (KFB), the
Korea Securities Dealers Association (KSDA), the Korea Life Insurance
Association (KLIA) and the Korea Investment Trust Companies Association (KITCA-for
all of them see the key contacts list on page 74) are examples of private/public
collaboration in enforcing government directives among member institutions. The
government also prefers to work behind these private entities when it wants to
exert influence on financial markets.
The FSC has pledged to continue to streamline rules and regulations and to
curtail "window guidance"-that is, unofficial exercise of bureaucratic
control over bankers and top managers of other institutions. Many notification
requirements have been removed, and more supervisory responsibility is being
handed over to private industry associations, according to the FSC. Effective
December 2000, all changes in the rules and regulations under the jurisdiction
of the FSC must be made public for at least ten days and revised, if necessary,
based on public suggestions before they become official. Under the "open
consultation" system, rules and regulations newly created, revised or
abolished will be published on the Internet and by the media for public
comments.
Meanwhile, the prime minister issued an executive order, effective November
13th 2000, to ensure "transparency of financial administration".
According to the instruction, the MOFE, the FSC, the FSS, the Korea Deposit
Insurance Corporation (KDIC-2.8) and other regulating agencies should stay away
from the management of financial institutions unless required by law to do
otherwise. Even intervention required by law should be communicated to the
institution in written documents, not by mere phone calls. Under the order, the
FSC is required to eliminate rules and regulations deemed "unreasonable and
unnecessary" for the operation and management of a financial institution.
1.3 Domestic banks.
The South Korean banking sector remains fragmented despite a recent series of
mergers. It has too many commercial banks to achieve economies of scale and
accumulate the vital know-how needed to survive global competition. In asset
terms, the average size of the major commercial banks is about one-fifth the
size of their counterparts in developed countries and smaller than the annual
sales of the biggest chaebols. One of the objectives of the financial reform
programme is to replace the current financial industry with a universal banking
system like that found in most Western countries.
The FSC anticipates that within the next few years leading domestic banks
will have total assets of more than W100trn, a bad-debt ratio of less than 1%,
return on assets of more than 1% and return on equity of more than 15%. The call
to create these leading banks does not, however, mean that industrial capital
will be allowed to buy out a commercial bank. The government is particularly
wary of chaebols' interest in banking, for fear of misuse and further
concentration of economic power. In general, chaebols are not allowed to hold a
controlling stake in any commercial bank, but they are not prevented from
building a new bank from scratch if they do not do so with borrowed money.
Non-financial institution ownership of commercial banks has remained highly
restricted. Individual private ownership in a national commercial bank was for
many years curtailed by the legal limit of 4% of equity (15% for a regional
bank). The Ministry of Finance and Economy eased these rules somewhat under an
amendment to the Banking Act, effective July 28th 2002. The ceiling on
permissible individual shareholding in a national commercial bank rose to 10%
and can be further increased on a case-by-case basis with approval from the
Financial Supervisory Commission (FSC-1.2). The ownership ceiling of 15% of a
regional bank remained in place. Many prudential requirements continue to apply
to acquisitions, including restrictions on voting rights of bank shares held by
industrial companies in excess of 4%.
As of end-2002 South Korea had eight national commercial banks: Kookmin Bank,
Woori Bank, Chohung Bank, Shinhan Bank, Korea Exchange Bank, Hana Bank (merged
with Seoulbank in December 2002), KorAm Bank and Korea First Bank (now majority
foreign owned). Three previous members of the national banking club-Dae Dong
Bank, Dong Hwa Bank and Dongnam Bank-were shut down and taken over by healthier
banks in June 1998. Peace Bank of Korea, the smallest national bank, was
combined with Woori Bank in 2001.
Kookmin, Shinhan and Hana are generally considered the soundest commercial
banks, and they have enjoyed an increasing flow of funds, which is expected to
contribute to further consolidation of the sector. Woori, once among the
country's largest banks, is still recovering from recent painful restructuring,
but it began to post profits in 2001 and remained profitable in 2002. For a list
of the country's largest domestic banks, see the table on page 14.
The national commercial banks are all-around players that lend to corporate
and retail customers. Most chaebol companies have close relationships with one
or two of them. The national commercial banks suffered heavy losses in the
financial crisis of 1997-98, and many of them have spent the past several years
cleaning up their loan books, restructuring their operations and returning to
profitability (1.1).
Top ten domestic banks
Ranked by assets as of end-June 2002-W bn
Market
Bank Assets share (%) Profit(1)
Kookmin Bank 161,038 23.79 1,164
Woori Bank(2) 88,630 13.09 731
Chohung Bank(2) 59,490 8.79 54
Shinhan Bank 57,700 8.52 306
Korea Exchange Bank 50,666 7.48 75
Hana Bank(3) 48,014 7.09 227
KorAm Bank(4) 32,279 4.77 131
Korea First Bank(4) 28,663 4.23 53
Seoulbank(2,3) 24,188 3.57 108
Daegu Bank 14,893 2.20 91
Total market 677,044 100.00 3,127
Notes: (1) net profit in the first half of 2001; (2) the government owns
majority stakes; (3) Hana Bank and Seoulbank merged on December 1st 2002;
(4) the government owns minority stakes.
Source: Financial Supervisory Commission.
There are also six regional commercial banks: Cheju Bank, Daegu Bank, Jeonbuk
Bank, Kwangju Bank, Kyongnam Bank and Pusan Bank. Two others-Chung Chong Bank
and Kyungki Bank-were closed down and taken over by other banks in June 1998.
The struggling Chungbuk Bank and Kangwon Bank merged with Chohung Bank in 1999.
The regional or "provincial" banks engage primarily in regional
funding operations. With their headquarters in the provinces, they serve small
and medium-sized businesses based in major provincial areas. Some also have
branches in big cities, such as Seoul. The regional banks have been forging
industry-wide alliances in recent years as part of their drive to compete with
the national banks. Interconnected networks already allow customers of one
regional bank to access their accounts for transactions through other regional
banks. In fact, the regional banks' combined network of 717 branches as of
mid-2002 made them equivalent in size to a medium-sized national bank.
South Korea's commercial banking sector was worth W677trn in asset terms as
of end-June 2002, up from W641.4trn at end-2001, according to the FSC. Their
combined outstanding won-denominated loans and discounts grew to W321.8trn at
end-June 2002, from W270.7trn at end-2001. The figure represents 31.9% of all
domestic credit (W1,009trn as of end-May 2002, based on Bank of Korea data).
Foreign companies operating in South Korea have free access to domestic bank
loans, but they prefer borrowing from foreign banks.
Commercial banks had been under virtual state ownership throughout their
recent history. The government has a history of meddling in the management of
commercial banks, which includes the nationalisation of five major banks in 1962
and continued ownership of them for two decades. The government long handpicked
executives of commercial banks, set credit quotas and identified lending targets
on their behalf, all in the name of rapid economic development. State guidance
enabled so-called strategic industries, such as automobiles, semiconductors,
shipbuilding, petrochemicals and steel, to spring up almost overnight on massive
infusions of capital at subsidised interest rates.
On the negative side, political corruption of the banking system became
rampant, with chaebols often taking advantage of institutional links between
powerful politicians and powerless bankers to finance projects of absurd
proportions. The concept of risk analysis and creditworthiness was almost
non-existent, with banks typically relying on real-estate collateral for large
exposures. A series of failures of chaebol touched off by the crisis of 1997-98
illustrated this fatal flaw of the banking system.
The FSC, the regulator, has endeavoured to straighten out the banking sector
in recent years (1.2). According to its count, non-performing loans at domestic
commercial banks (excluding mutual and foreign banks) stood at W8.7trn, or 1.9%
of total loans at end-September 2002, a vast improvement from the level seen
during the 1997-98 crisis. Much of the reduction has been achieved through
liquidations of collateral, debt securitisation, debt-for-equity conversions and
outright sales of claims.
Commercial banks have recently clawed their way back to profitability, with
combined net income of W4.02bn in the first nine months of 2002. This compared
with net income of W3.57trn for the whole of 2001 after a net loss of W2.84trn
in 2000. Returns on assets averaged 0.8% in 2001 (the latest figure available
from the FSC), after registering negative numbers for four consecutive years
from 1997. Nevertheless, banks' risk analysis and management techniques remain
relatively underdeveloped; risk-adjusted return on capital, a tool widely used
in Western banks, is still a new concept for Korean banks.
The government's aggressive recapitalisation campaign is credited with at
least part of the improvement. But it means that the government now has
controlling stakes in many commercial banks, a situation that also prevailed
before the 1980s. Woori and Chohung have been almost completely nationalised.
Seoulbank (now part of Hana Bank) came under 100% government ownership as a
result of its publicly funded recapitalisation. Korea First was nationalised and
then sold to Newbridge Capital of the US in December 1999, but the government
still holds a 49% stake. The government also owns 36% of Korean Exchange Bank.
The government intends to start sales of its majority stakes in Woori and
Chohung, and its minority stakes in Korea First and Korea Exchange, once these
banks show an ability to earn an attractive return on equity. Chohung is already
on the auction block, and the government chose Shinhan Financial Group as the
prime bidder in December 2002. The sale is expected to be completed shortly
after South Korea's new president, Roh Moo-Hyun, takes office on February 25th
2003.
The government has said repeatedly that the banks will be run independently,
but in reality, there is ample evidence of persistent government intervention.
The government's official policy on the mobilisation of public funds is that
they should only be used to carry out the liquidation of failed institutions and
restructure weak but viable banks. Restructuring that involves the use of public
funds should be limited to private-sector recapitalisations, direct
recapitalisations by the government, to purchase and assumption transactions,
and to mergers and foreign investments approved by the FSC.
The authorities have promoted the formation of holding companies as a
precursor to the introduction of universal banking. They are eager to see one or
more of South Korea's financial holding companies join the ranks of the world's
largest integrated financial-services groups.
Several of these financial groups have already appeared. Woori Financial
Holding was launched in April 2001 as the nation's first such conglomerate,
based on a collection of financial institutions most heavily recapitalised by
the government. It has under its roof four of the six previously non-viable
banks (Woori, Kwangju, Kyungnam and Peace Bank of Korea) and Hanaro Investment
Bank, one of the three remaining merchant- banking corporations.
Shinhan Bank, one of the leading commercial banks, came under a holding
company with the bank's investment-banking and fund-management arms in September
2001. It grew to include a regional bank, Jeju Bank, in May 2002.
The Financial Holding Company Act of November 24th 2000 has the following
features:
* A financial holding company, authorised by the FSC, must own at least 50%
of each of its subsidiaries (30% for a listed subsidiary) and comply with a set
of regulations set by the Korea Fair Trade Commission, including a maximum
debt-to-equity ratio of 100% and rules on stock swaps and transfers;
* It cannot own another financial holding firm, and individual ownership of a
bank holding company must be limited to 10% (15% if based on a regional bank);
* It will be subject to prudential guidelines, including restrictions on
lending to a single borrower and a large shareholder, and "Chinese
Wall" requirements for cross-subsidiary dealings; and
* If the government holds a controlling stake, it must unwind the publicly
owned position over a three-year period (extendable by one year).
Mutual savings banks and credit unions cater to the financing needs of
households and do not deal with foreign businesses in South Korea. They provide
small loans, with funds financed through time deposits. Regulatory oversight has
been lax, with the result that loan scandals and other corrupt practices have
eroded confidence in these institutions, and many of them have failed in recent
years. The combined assets of mutual savings banks and credit unions stood at
W25.7trn and W98.9trn, respectively, at end-June 2002.
Mutual savings banks (formerly mutual savings and finance companies) are
mini-banks specialising in the retail market. They became targets for reform
following a series of scandals in 2000. A series of bank runs reduced many of
them to insolvency at that time. As a result, they numbered just 117 at end-June
2002, from 231 at end-1997.
The FSC has targeted mutual savings banks that have capital-adequacy ratios
of less than 4% for serious prompt corrective action (PCA-1.2), including forced
liquidation. At the same time, it has begun to increase its surveillance of
mutual savings banks that have loans extended to a large shareholder in excess
of 10% of their equity capital, in order to prevent them from becoming private
"piggy banks". Anyone seeking to acquire a stake of 10% or more in a
mutual savings bank is now required to obtain official approval.
Credit unions are even smaller versions of mutual savings banks. They have
problems similar to their larger counterparts, and their ranks are also
dwindling. At end-June 2002 some 1,252 credit unions were still in operation,
down from 1,666 at end-1997. The FSC put 115 non-viable credit unions under the
PCA programme in November 2002.
1.4 Foreign banks.
It was not until 1967, when Chase Manhattan Bank (now JP Morgan Chase of the
US) opened a branch in Seoul, that foreign banks began to set foot in South
Korea. Foreign banks now carry on their business under regulatory conditions
almost identical to those of their local counterparts, but they are mostly
exempt from the meddlesome influence of the government.
Top ten foreign banks
Ranked by assets at end-June 2002-W bn
Market
Bank Assets share (%)
Citibank (US) 12,130 1.79
HSBC (UK) 4,986 0.74
JP Morgan Chase (US) 4,055 0.60
Deutsche Bank (Germany) 3,729 0.55
Standard Chartered Bank (UK) 3,451 0.51
Credit Suisse (Switzerland) 3,026 0.45
BNP Paribas (France) 2,241 0.33
Credit Lyonnais (France) 2,174 0.32
ABN Amro Bank (Netherlands) 2,149 0.32
ING (Netherlands) 2,045 0.30
Total market 677,044 100.00
Source: Financial Supervisory Commission.
Lacking a branch network, most foreign banks are unable to raise much in
terms of won-denominated deposits; thus their retail operations remain small and
narrowly focused on a limited number of wealthy customers. Citibank (US), the
largest foreign bank, remains smaller in asset terms than all eight of the
national commercial banks. The advantage of many Western banks is their ability
to raise funds globally at lower costs than their local counterparts, and thus
to offer better terms to borrowers.
Foreign banks are expanding, however, amidst the broad and deepening reform
of the South Korean financial industry. Entry barriers were already beginning to
collapse in the mid-1990s. The so-called "economic needs test" on
foreign applications for banking licenses was abolished in April 1994, an entry
rule that required a foreign bank to set up a representative office first before
branch operations was lifted in May 1995, and another rule that allowed only the
world's 500 largest banks to enter the market was repealed in February 1997.
Established foreign banks have been allowed to set up subsidiaries in the
country under the Banking Act from April 1998. Foreign banks now have access to
the rediscount window of the Bank of Korea and have permission to issue trusts
and certificates of deposit.
Greater foreign ownership of domestic commercial banks has been allowed since
January 1998. Korea First Bank became the first traditionally domestic bank to
come under entirely foreign management when the investment company Newbridge
Capital (US) bought a majority stake in December 1999. KorAm, likewise, came
under foreign control when the Carlyle Group (US) succeeded in forming a
consortium to buy a 40.1% stake in November 2000. These two banks continued to
be classified as "national commercial banks."
There were 63 branches of 41 foreign banks operating in the country at
end-June 2002. The largest, with established local retail networks, were
Citibank (US-12 branches) and HSBC (UK-7 branches). They were followed by JP
Morgan Chase (US), Deutsche Bank (Germany), Standard Chartered Bank (UK) and
Credit Suisse (Switzerland). For a list of the country's largest foreign banks,
see the table at left.
These foreign banks (excluding Korea First and KorAm) held a total of
W52.3trn in assets at end-June 2002, resulting in a combined market share of
7.8%, up from 5.7% the year before, according to the Financial Supervisory
Commission (FSC). In terms of outstanding loans and deposits, their combined
share stood at 1.6% and 2.3% in mid-2002, down from 2.1% and 2.4%, respectively,
in mid-2001.
Foreign bank branches without retail muscle are finding it increasingly
difficult to run profitable operations in South Korea. Corporate debt reduction
efforts and tougher corporate lending regulations are drying up their sources of
profit. Some foreign banks have simply packed up and left after suffering from
lacklustre business. In 2002 alone, Bank of New York (US), Fleet National Bank
(US) and Fuji Bank (Japan) withdrew from their operations in South Korea.
However, other foreign banks-notably Citibank and HSBC-are finding profitable
niches among high net-worth South Korean retail customers, using their global
network and superior banking strategies as selling points.
Apart from Citibank and HSBC, which are strong in both retail and wholesale
operations, foreign banks tend to focus on cash management, foreign-exchange
services and derivatives transactions with corporate customers, including South
Korean multinational corporations. On the lending front, the foreign banks offer
a slight advantage over their South Korean counterparts because of their lower
cost of raising capital on international markets.
1.5 Investment banks & brokerages.
South Korean securities companies and investment banks have undergone
dramatic realignment since the 1997-98 financial crisis. Their numbers have
fallen dramatically, and subsequent reform has opened the once-closed sector to
foreign competition.
Among securities companies, the South Korean equivalent of Western investment
banks, change has been so broad that only a few of the 36 companies that existed
at end-1997 remain in their original form. Many of the 44 securities companies
in operation as of end-June 2002 have been newly established, converted from
different types of business or switched to foreign management.
Securities companies in South Korea are involved in dealing securities for
their own accounts or on consignment; dealing securities as brokers,
intermediaries or agents; underwriting securities; arranging for public
offerings of securities; selling repurchase agreements, commercial paper (CP),
investment trusts and bond-fund beneficiary certificates, and mutual funds;
trading certificates of deposit; and accepting deposits of securities savings.
They have been able to trade and broker CP and issue corporate bonds since July
1997. They were allowed to set up brokerage- only subsidiaries offering
commission-based brokering services, including online transactions, from June
1999.
The top firms in the industry include subsidiaries of South Korea's principal
conglomerates, or chaebol, such as LG Investment & Securities and Samsung
Securities. These two full-service securities companies have managed to hold on
to their dominance in stock brokerage despite industry turmoil in recent years.
By contrast, the securities arms of Hyundai and the now defunct Daewoo Group
have dropped out of the leading pack. Daewoo Securities, once the industry
leader, was taken over by the Korea Development Bank in May 2000 and is now
awaiting a new buyer. For a list of the country's largest securities companies
ranked by assets, see the table above.
The FSC's securities-related guidelines call for minimum-capital requirements
for domestic and foreign entities seeking to expand or diversify their
operations: W50bn for an integrated full-service securities company (authorised
for brokerage, dealing and underwriting operations); W25bn for a mortgage-backed
securities company; W20bn for a dealing and brokerage company; W10bn for a
fund-management company; W3bn for a brokerage-only or futures trading firm; and
W1.5bn for a credit- rating agency. In addition, the FSC requires all securities
companies to separate clients' funds from proprietary accounts; and to follow
official guidelines to account for and manage market and business risk.
Foreign investment banks have been allowed to buy unlimited stakes in
domestic securities companies since January 1998, and they have been able to
establish local subsidiaries since April 1998. Many global investment banks
already have operations, some in joint ventures. At end-June 2002 there were 18
foreign securities companies operating in South Korea.
Top ten securities companies
Ranked by net profits in half year to September 2002-W 100m
Firm Profit
LG Investment & Securities 802
Samsung Securities 737
Morgan Stanley (US) 293
Goldman Sachs (US) 278
UBS Warburg (Switzerland) 235
Daeshin Securities 208
Merrill Lynch (US) 200
Good Morning Shinhan Securities 178
BA Asia 168
ING Barings (Netherlands) 142
Note: The industry suffered a combined net loss of W112bn for the April-
September period.
Source: Financial Supervisory Commission.
The FSC warned foreign investment banks in March 2002 to comply with its
sectoral business demarcation guidelines (1.2), citing their blurring of the
line between commercial and investment banking. The commission said some foreign
investment banks used a "European-style" universal banking practice to
evade sectoral regulation in South Korea. For instance, the FSC claimed to have
observed exchanges of customer information between the commercial and investment
banking arms of the same brokerage house, a practice prohibited under South
Korean financial laws.
The FSC increased its oversight of brokerage analysts in light of the global
trend toward tougher ethical discipline for stock analysts. The agency now works
more closely with the KSDA in the areas of enforcing internal "Chinese
Walls" and fair client access to analysts' reports, and preventing
conflicts of interest involving research and trading. The FSC began to apply
more stringent procedures for distributing analysts' reports from July 2002.
Under the revised rules, securities companies must disclose in analysts' reports
any third-party organisations and individuals given access to research before
publication to the investing public. The FSC will monitor brokerage research and
sales activities linked to stock recommendations and take appropriate regulatory
action, if necessary.
The KSDA announced its own rules in July 2002, imposing even stricter
requirements on member firms and their securities analysts, to promote
independence and objectivity of brokerage research. The rules, effective August
1st, include a ban on stock trading by member securities companies or their
analysts based on unpublished research information. The rules also stipulate
that securities research reports must explain how recommendations and price
targets on researched stocks have changed over the last one-year period. In
addition, research findings should not be made available to the investment
banking department or the company being researched before their publication.
KSDA member companies must establish standard operating and internal control
procedures for the proper distribution of analyst reports. Member firms are
prohibited from doing research on companies with which they have
"significant interests", such as existing investment banking clients.
By the same logic, they are not allowed to conduct securities research on a
company of which they own 5% or more. Companies with audit problems are also
excluded from brokerage research.
The FSC and KSDA efforts to bring more discipline to stock research practices
followed a series of scandals involving global investment banks. During 2002 the
FSC found UBS Warburg (Switzerland) and Merrill Lynch (US) guilty of leaking
market-sensitive information to clients before release to the wider market and
slapped the firms with penalties that included forced temporary pay cuts and the
suspension of some employees.
Merchant banking corporations, or merchant banks, have dwindled in numbers,
falling from 30 at end-1997 to only three at end-June 2002. In the mid-1990s
most had raised cheap funds abroad and invested them in emerging markets or lent
them to South Korean chaebol. Many of these placements later turned sour and
they were unable to tap additional foreign funds. In the years following the
1997-98 financial crisis, most merchant banks were closed down, merged, or
converted to securities companies. All three remaining merchant banks will
eventually turn into investment banks, as financial reforms and deregulation
make their field of specialisation increasingly meaningless.
Merchant banks engage mainly in bill and CP discounts, leasing and
crossborder financing activities. They sell investment trusts and underwrite
corporate bond issues. Since July 1997 merchant banks with a capital stock of
more than W30bn, or shareholder equity of more than W100bn, have been allowed to
trade securities and underwrite new stock issues.
Under the FSC's reform plan, a merchant bank may merge with a securities
company or a commercial bank and retain some of its existing business lines as
long as there is a line separating merchant banking from securities or banking
operations. For example, a securities company combined with a merchant bank may
conduct short-term financing and leasing operations for five years after the
merger. These institutions have been required since June 2000 to observe the
same loan classification, provisioning and capital-adequacy mandates, including
forward-looking criteria, that apply to commercial banks.
Korea Securities Finance Corp (KSFC-see the key financial contacts list on
page 74) makes loans to underwriters, lends money or securities to securities
companies and individuals, conducts bond trading under repurchase agreements,
acts as a securities custodian and administers stocks deposited within companies
by employee stock-ownership associations. Securities and futures companies are
required to place customer deposits at the KSFC for safekeeping. It has a legal
monopoly in these areas and is jointly owned by banks, securities companies and
other financial market participants.
1.6 Development & postal banks.
South Korea's state-owned policy banks include the Korea Development Bank,
the Export-Import Bank of Korea and the Industrial Bank of Korea (see the key
financial contacts list on page 74). The first two are classified as development
institutions by the central bank, while the Industrial Bank of Korea is lumped
together with the National Agricultural Co-operative Federation and the National
Federation of Fisheries Co- operatives as a specialised bank. Another
development bank, the Korea Long-Term Credit Bank, was absorbed by Kookmin Bank
in early 1999.
These banks are valuable sources of medium- and long-term credit for small
and medium-sized firms, heavy-industry sectors dominated by chaebol
conglomerates and other export industries. They are funded by the government, by
deposits, by foreign investment and through the issue of their own special
debentures. Their clientele are mostly domestic companies, although there are no
restrictions on foreign enterprises accessing their loans.
The Ministry of Information and Communication operates an extensive network
of post offices, which offer a range of time and savings deposits as well as
personal insurance products. Post offices issue their own cheques (cashier's
cheques) and postal money orders, and provide interbank fund transfers and ATM
(automated teller machine) services. The decline of public confidence in banks
and insurers in recent years has helped boost the popularity of postal financial
products vis-a-vis those offered by conventional banks and insurers. As part of
the government system, postal savings schemes are free from business risk, a
feature that was made even more attractive in January 2001 with the lifting of
blanket deposit insurance (2.8).
1.7 Offshore banking.
There are no offshore banking centres that operate outside the normal
regulatory environment. However, foreign-exchange banks have been allowed to
conduct offshore banking business since 1987 as part of the internationalisation
of South Korean financial institutions. Reserve requirements and corporate tax
codes do not apply to offshore financial accounts. Each foreign-exchange bank
engaged in offshore financial transactions must establish a set of offshore
financial accounts clearly separate from its domestic accounts. No transfer of
funds between offshore accounts and domestic accounts is permitted, except for
transfers from domestic accounts to offshore accounts amounting to 10% or less
of the offshore foreign-currency assets. This limit was increased from 5% on
July 1st 2002.
Foreign-currency funds for offshore financial transactions may be raised
through borrowings and deposits from non-residents or other offshore financial
accounts, and through the issuance of foreign-currency securities on foreign
capital markets. Foreign-exchange banks may operate foreign-currency funds for:
(1) lending to and depositing with non- residents or other offshore financial
accounts; and (2) the underwriting, sale or purchase of foreign-currency
securities issued by non-residents.
Corporations and financial institutions setting up and operating offshore
funds are now subject to tougher prudential and disclosure requirements under a
revision to crossborder securities regulations under the Foreign Exchange
Transaction Act (5.1). In the past, lax regulation had allowed some investors of
South Korean origin to use offshore funds to bypass local securities
regulations.
The revised regulations took effect on November 6th 2001, targeting offshore
funds established as paper companies abroad and run by South Korean investors
and foreign firms operating locally. Under the revision, investment in such
offshore funds will be treated as foreign direct investment, as opposed to
portfolio investment, and thus must comply with the many prudential and
disclosure rules that govern subsidiaries. These include capital-adequacy and
risk-management requirements, and restrictions on parent investment of equity
and debt capital as well as cross-subsidiary transactions.
The new rules are aimed at increasing transparency in financial activities
via offshore fund centres abroad, as investors are now held accountable for the
full regulatory compliance of their offshore funds. These funds should appear as
subsidiaries on their financial statements subject to regulatory supervision
under the Securities and Exchange Act.
According to the FSC, some offshore funds financed by South Korean capital
have been used as vehicles of market manipulation under the guise of foreign
portfolio investment. The FSC has said it will publicise any violation of rules
by offshore funds as a warning to other investors and financial institutions
against transactions with such funds. Previously, South Korean regulation on
offshore funds existed only in the form of prudential standards for portfolio
assets, and disclosure requirements on offshore funds were only relevant to
investment banks and other asset managers.
The revision does not apply to special-purpose vehicles set up abroad to
facilitate asset securitisation, aircraft and shipbuilding acquisition, and
offshore holding companies that control manufacturing and financial services
subsidiaries. However, all offshore funds must be reported to the central bank.
2.0 Other financial institutions - 2.1 Insurance companies.
South Korea's insurance industry has a relatively short history, with the
first group of insurers appearing only in the late 1940s. However, its growth
has been as spectacular as the country's economic development. The ratio of
total insurance assets to gross domestic product jumped to 36% in 2001, from
less than 2% in 1970.
South Korea has the largest insurance industry in Asia outside Japan. Life
and non-life insurers attracted W60trn in premiums written in 2001, according to
the Financial Supervisory Commission (FSC-1.2). In the half- year between April
and September 2002 they gained an additional W33trn (W23trn in life insurance
premiums and W10trn in non-life insurance premiums), according to government
figures.
There were 22 life insurance companies (including nine foreign insurers and
two South Korean-foreign joint ventures) and 22 non-life companies (including
five foreign insurers) as of end-June 2002. In addition, there is Postal Life
Insurance, which falls under the jurisdiction of the Ministry of Information and
Communication (1.6).
Under South Korea's Insurance Business Act, the life and non-life sectors are
strictly divided; life insurers are banned from offering non-life products in
principle, and vice versa. Roughly three-fourths of insurance business is
conducted by life insurers, while a still very small portion of life and
non-life business is accounted for by foreign companies. Official barriers to
foreign entry do not exist, except for a 49% ceiling on foreign investment in a
joint venture. There is a special clause restricting chaebols' entry into the
industry; a chaebol seeking to acquire an existing insurer or set up a new one
must take over two non- viable insurers on the market as a condition for its
entry.
More than 40% of the population is covered by life insurance. Life insurers
also offer pension annuities. There are signs that the traditional preference
for life insurance products with savings features is waning. For the first time
ever, the share of savings insurance products in total premium income was
outpaced by that of insurance-only products (including whole-life policies),
49.6% to 50.4%, in the April- September period of 2002.
Top ten insurance companies
Ranked by premium income in half year to September 2002-W bn
Life insurance
Premium Market
Company income share (%)
Samsung Life Insurance 9,199 40.08
Korea Life Insurance 4,468 19.47
Kyobo Life Insurance 3,816 16.62
Allianz First Life Insurance 1,095 4.77
SK Life Insurance 614 2.67
Tongyang Life Insurance 576 2.51
Hungkuk Life Insurance 559 2.44
ING Life Insurance 484 2.11
Shinhan Life Insurance 455 1.98
Kumho Life Insurance 445 1.94
Total market 22,952 100.00
Non-life insurance
Premium Market
Company income share (%)
Samsung Fire & Marine 3,031 30.15
Hyundai Fire & Marine 1,414 14.06
Dongbu Fire & Marine 1,331 13.24
LG Fire & Marine 1,281 12.75
Oriental Fire & Marine 775 7.71
Seoul Guarantee Insurance 443 4.40
First Fire & Marine 441 4.38
Ssangyong Fire & Marine 407 4.05
Sindongah Fire & Marine 383 3.81
Daehan Fire & Marine 251 2.50
Total market 10,052 100.00
Source: Financial Supervisory Commission.
The life sector has seen many new entrants since deregulation in 1987, but
the largest three-Samsung Life, Korea Life and Kyobo Life-still dominate the
market, accounting for 76% of all premiums written between April and September
2002. Samsung alone controls more than 40% of the market. The non-life sector is
somewhat less concentrated: Samsung Fire & Marine, the leader, accounts for
over 30% of the market. It is followed by Hyundai Fire & Marine, Dongbu Fire
& Marine and LG Fire & Marine. For a list of the country's top
companies, see the table above.
The foreign share of the life insurance market remains small at 10.9%, but
economic reform is opening a window of opportunity for foreign insurers.
European insurance giant Allianz (Germany) completely took over a major life
insurer, First Life, in August 1999. Other major insurance companies, such as
Prudential (UK) and ING (Netherlands), are enjoying rapid growth in new business
based on their superior expertise.
Since 1998 the FSC has been busy sorting out non-viable insurers under
tougher solvency margin requirements. As a result, several non-viable insurers
were closed down, while some others, including Korea Life Insurance, are under
continuing review. Insurers failing to meet the required solvency margin
thresholds of 100% will be subject to prompt corrective action (PCA-1.2).
The FSC extended relevant banking regulations to insurance companies in the
areas of loan classification, provisioning, large exposure, connected lending
and disclosure rules in July 2000. It required them to institute forward-looking
asset valuation criteria in August 2000. Insurers are required to limit loans to
non-policy holders to 40% of total assets, and they must reduce this figure over
time.
The FSC enforces strict investment guidelines for insurers. However, an
amendment to the Insurance Business Act, which took effect on March 25th 2002,
relaxed these restrictions. The revised rules include the following:
* Investment in non-listed stocks must not exceed 10% (5% through March 2005)
of the insurer's total assets;
* Investment in real-estate property must not exceed 25% of total assets;
* Foreign currency and foreign real-estate holdings must not exceed 30% of
total assets;
* Credit allowances to a single individual borrower must not exceed 3% of
total assets. The exposure limit on lending to a single corporate borrower is 7%
of total assets;
* Credit allowances to a major shareholder must not exceed 40% of the
insurer's net worth, or 2% of its total assets, whichever is smaller; and
* Credit allowances to a company affiliated with the insurer must not exceed
10% of the insurer's net worth.
Another amendment to the Insurance Business Act has been prepared by the
Ministry of Finance and Economy (MOFE) and will be submitted to the National
Assembly sometime in 2003 (for details see the legislative watchlist on page
32).
Liberalisation of life and non-life premiums has been completed according to
a schedule established in 1993 and revised in March 1999. Life premiums have
been fully freed since April 2000, and non-life premiums, which have been
partially liberalised since April 1997, have been freely set by insurers since
April 2002. In addition, life and non-life insurers have been allowed to raise
funds from commercial paper and corporate bond issues since October 2001.
There is no vertical integration between banks and insurers, although life
insurance companies lend heavily to the corporate sector, especially to large
companies affiliated with chaebols. At end-June 2002 outstanding loans at life
insurance companies stood at W40.8trn, or 27.5% of their combined invested
assets.
Meanwhile, the current three-year grace period on a measure allowing banks
and securities companies to sell insurance policies as sales agents will expire
in August 2003. The deregulation measure, aimed at opening an era of
bancassurance in South Korea, was provided by revised rules under the Insurance
Business Act, which took effect in August 2000.
2.2 Pension funds.
Public-sector social security. Under the National Pension Act introduced in
1988 and covering all workplaces with five employees or more, workers pay up to
9% of their monthly income, half subsidised by employers, to the national
pension schemes. These plans start paying out monthly individual pensions at the
age of 60. In April 1999 the scheme was expanded to include all urban
self-employed citizens who were previously exempt from the mandatory social
security. Separate pension funds exist for agricultural workers, teachers and
civil servants.
The National Pension Corporation (NPC-see the key financial contacts list on
page 74), under the Ministry of Health and Welfare, directly controls national
pensions. It had 16.4m subscribers, W77trn in premium deposits and W91.1trn
under management as of end-November 2002. The national pension funds were long
considered a second budget for the government, with no legal guidelines on their
reinvestment and management. Direct allocations to the government have been
phased out, however, and any pension fund appropriations to the government now
have to be made through fund acquisitions of public-sector bonds.
The NPC launched an in-house fund-management unit, with a group of
professional managers hired from the private sector, in November 1999. The
fund-management centre executes portfolio investment strategies set forth by an
independent committee of public- and private-sector representatives. As of
end-November 2002 some W30.8trn, or 34% of its funds under management, went into
public and welfare projects, with the rest placed in financial markets. Some
W54.6trn, or 91% of the funds placed in financial markets, were invested in
fixed-income securities and another 4.9% were invested in stocks-a very low
level by international standards.
A December 2000 amendment to the National Pension Act lifted a ban on
investment in foreign securities, venture capital and exchange-traded
derivatives. The government also plans to ease restrictions on stock investment
by public pension funds to buttress the local stockmarket.
In a further effort to make public fund management more efficient, the
Ministry of Budget and Planning launched an "investment pool management
committee" in August 2001. The committee, consisting of private- and
public-sector experts, selects professional fund managers to operate public
funds under outsourcing contracts and monitor their performance. As of December
2002 a total of 34 firms were under outsourcing contracts to manage public funds
on financial markets, including two foreign managers: Franklin Templeton
Investment Trust Management (UK) and Hana Allianz Investment Trust Management (a
joint venture between Germany's Allianz and South Korea's Hana Bank).
The NPC's portfolio allocation plan for 2003 includes putting W85.3trn, or
90.5% of total portfolio assets, estimated at W94.2trn, in fixed-income
securities. Some 8.7% will be placed in stocks, and the remaining 0.8% will be
made available for so-called alternative investment including real-estate
investment trusts (REITs), project financing and private- equity funds.
South Korea's private pension-fund market has undergone major changes since
the introduction of personal pension plans in 1994. All domestic financial
institutions are now allowed to sell personal pension plans. There are,
unfortunately, no available aggregate figures for this market.
Insurance companies have been allowed to sell "occupational"
pension plans since April 1999. The difference between personal and occupational
plans is that premiums for the latter are entirely paid by employers hiring five
or more employees as an alternative to the severance pay schemes required by the
Labour Standards Act. In March and September 2000, commercial banks and
investment-trust management companies, respectively, were also given the
go-ahead to market occupational plans as trust accounts.
Additionally, life insurers and commercial banks offer employee pension plans
to companies that are legally required to set aside certain portions of regular
employee compensation as accruements to severance pay. Life insurers serve as
custodians and fund managers for the employee pension funds, and employers can
take out loans against the funds, which is not allowed for occupational pension
plans.
In September 2000 the three largest life insurers-Samsung Life, Korea Life
and Kyobo Life-were allowed to sell a single-premium immediate annuity to people
aged 50 and older. The government hopes these pension schemes will eventually
replace the country's outdated severance pay system, which requires employers to
set aside large amounts of money to meet future retirement pay-outs, equivalent
to years of salary for senior retirees-one of the frequent complaints from local
and foreign businesses.
Top ten investment-trust management companies
Ranked by total assets under management as of end-2002-W bn
Market
Company Assets share (%)
Samsung 25,544 15.27
Daehan 18,179 10.87
Korea 17,629 10.54
Hyundai 16,830 10.06
CJ 11,706 7.00
KB 10,191 6.09
LG 8,730 5.22
Chohung 6,806 4.07
Shinhan BNP Paribas 4,663 2.79
Tong Yang 4,360 2.61
Total market 167,231 100.00
Source: Korea Investment Trust Companies Association.
A new corporate pension scheme may be introduced as early as 2003 as a South
Korean version of the US 401 (k) pension programme. See the legislative
watchlist on page 32.
2.3 Mutual funds.
Investment trusts have long been the main investment vehicle for indirect
stockmarket investment in South Korea. Investment-trust management companies
drive this market, which was worth W167.2trn in outstanding investment in stock,
bond and hybrid funds as of end-2002, compared with W155trn a year earlier.
Under local securities laws, they are separate from investment companies that
offer mutual funds.
There were 31 investment-trust management companies developing, marketing and
managing trusts as of end-June 2002. Samsung, Daehan, Korea and Hyundai are the
four largest companies, with a combined market share of 47% at end-2002. For a
list of the country's top investment-trust management companies, see the table
above.
Banks, securities companies, insurers and foreign and domestic individuals
are allowed to establish investment-trust management companies. Banks,
securities companies and merchant banking corporations can directly sell and
manage investment trust funds. Merchant banks can sell only their own investment
trusts that they manage themselves, and their market share is small. Since
August 1995 investment-trust management companies have been allowed to operate a
securities arm.
Foreign investment-trust management companies have been entering the local
market since 1994. Until rules were loosened in May 1998, they were required to
form joint ventures with domestic firms and hold stakes below 50%. For a foreign
investment-trust management company, the minimum asset requirement is W5trn in
worldwide assets, compared to W10bn for local companies. Only four- Deutsche
Asset (Germany), Franklin Templeton Investments (US), Prudential (UK) and
Schroders (UK)-have wholly owned investment-trust management company licences. A
growing number of foreign companies-including Alliance Capital (US), Allianz
Insurance (Germany), BNP Paribas (France), Commerzbank (Germany) and ING Barings
(Netherlands)- are entering the market under joint ventures.
Investment-trust management companies develop, sell and manage trusts tied to
stock or bond funds through beneficiary certificates. Stock funds and bond funds
(including money-market funds) must have at least 60% of their assets invested
in their respective core securities. There are other variations: conversion or
"chameleon" investment trusts that allow investors to switch between
equity and bond-type funds, spot funds that allow investors to redeem their
investments after reaching a predetermined target rate of return, and
derivatives investment trusts that are exposed to derivatives such as
interest-rate futures. There are also funds that specialise in various
high-yield bonds, and many of these funds have tax- exempt features to attract
less risk-averse investors.
The Financial Supervisory Commission (FSC) has dictated prudential measures
aimed at curbing chaebols' access to financing through affiliated
investment-trust management companies. Managers must not invest in stocks of
affiliated companies in excess of 10% of their assets under management. The same
10% ceiling applies to mutual-fund managers. This ratio was increased from 7% by
an amendment to the Securities Investment Trust Business Act in September 2001.
As a general rule, investment-trust and mutual funds must not invest more than
10% of their portfolio assets in a single stock. Investment-trust management
companies can also face prompt corrective action (PCA-1.2) by the FSC if they
fail to manage their exposures to risky assets.
Investment trusts can be either fully underwritten by institutions for sale
to the public, or directly sold to investors through public offerings. Private
placements are also possible. Investment trusts are open-end funds that allow
investors to redeem their investments before maturity, albeit with penalties for
early redemptions (a minimum 70% of the accrued return has to be charged as a
redemption fee for a holding period of less than 90 days). Funds set up before
November 1998 were carried on a book-value basis, which distorted the asset
picture of the companies. Funds launched in November 1998 and thereafter have to
be marked to market, and since July 2000 any new investment in funds not marked
to market, other than money-market funds, has been prohibited. At the same time,
investment-trust management companies were required to report quarterly the
market value of all funds under man agement to the FSC.
Before these prudential and disciplinary steps were taken, the local
investment-trust industry was prone to market abuses and financial crises. The
government frequently misused management companies as tools of intervention in
financial markets. In the late 1980s the authorities told them to buy stocks
worth trillions of won to lift the collapsing local stockmarket. The operation
failed miserably and wreaked havoc on the companies' balance sheets. The
industry is still recovering from this legacy of state control of the market.
Mutual funds. Since September 1998 investors have been allowed to incorporate
investment companies that develop, sell and manage mutual funds, also known as
"corporate-type investment trusts", in South Korea. As the name
suggests, these closed-end mutual funds are put under management by
investment-trust management companies, which also recruit mutual-fund investors.
Commercial banks and securities companies provide additional sales channels.
There were 202 such funds worth W8.8trn in combined capital stock as of
end-April 2002. The typical maturity of these funds is one year. As in the US,
mutual funds can be listed on the stock exchange for trading, giving them an
attractive liquidity feature.
New regulations under the Securities Investment Company Act, effective
September 26th 2002, lowered the required minimum paid-in capital for an
investment company to W100m, from W400m. The revision, aimed at making it easier
to establish investment companies, increased the minimum net-asset maintenance
requirement to W1bn from W200m for "sound management" of investment
companies.
Semi-open-end mutual funds became available to investors under an amendment
to the Securities Investment Company Act, effective August 5th 2000. This new
type of fund allows redemption three to six months after an initial investment.
More specifically, investors can redeem up to 50% of their shares after three
months and the full amount after six months. Like open-end funds, these
semi-open-funds can create new shares continuously to attract new investors
without specific maturity. However, unlike the previously existing closed-end
funds, the semi-open funds are not listed on the stockmarket. This hybrid
feature makes the semi-open-end mutual funds more attractive to investors and
helps reduce market volatility. By contrast, when a closed-end investment
company dissolves, fund managers have to unwind their positions all at once to
return cash to investors.
Fully open-end mutual funds made their debut, under the same amendment, in
February 2001. They must follow certain portfolio requirements, including cash
and cash equivalents above 10% of portfolio assets. These funds can augment
liquid assets by borrowing up to 10% of their assets from financial
institutions. Fund managers are free to determine their own sales charges and
management fees. However, those managing level-load funds are required to charge
fees equivalent to 70% of capital gains for early redemptions within the first
three months of their operation. There are no available aggregate figures for
this market.
Real-estate investment trusts (REITs) are a new addition to South Korea's
growing list of mutual funds and investment trusts. The introduction of a REITs
law in April 2001, and its subsequent implementation in the following July,
marked the beginning of real-estate securitisation for the local investing
public. However, as of December 2002 no REIT fund had yet been established.
Several attempts to launch REIT funds fell apart after failing to attract
investors.
Although the conventional REIT market remains in limbo, a variant of this
market has already taken off. An amendment to the existing REITs law, enacted in
May 2001 and put into effect in the following July, introduced corporate
restructuring funds investing in real estate. Known as CR-REITs, these REIT
funds are exempt from many of the restrictions placed on regular REITs on
condition that they have at least 70% of assets in real estate sold by companies
under restructuring, liquidation or court reconciliation programmes. The first
CR-REIT fund, Kyobo-Meritz First, was offered to the public in November 2001 and
launched in January 2002. Two more CR-REIT funds were also launched in April and
October 2002.
2.4 Asset-management firms.
Broadly defined, the asset-management industry in South Korea includes
investment trusts, mutual funds, and trust accounts of commercial banks and
securities companies. For regulatory purposes, the industry refers to 12
asset-management companies authorised by the FSC and 125 investment advisory
companies registered with the FSC as of end-March 2002 under the Securities and
Exchange Act. Asset-management companies can only manage mutual funds;
investment-trust management companies can have both unit trusts and mutual funds
under management (2.3). Investment advisory companies provide advice and may
conduct discretionary investment business for clients. Of the 12
asset-management companies, 11 also have investment advisory operations.
Funds under management by asset-management companies increased to W6.41trn at
end-March 2002, from W2.02trn a year before. The top three firms had a combined
53.4% market share. Funds under advisory and discretionary investment contracts
with investment advisory firms more than doubled, to W20.77trn at end-March
2002, from W7.49trn a year earlier.
Increasingly, commercial banks are introducing the Western concept of private
banking, and securities companies are packaging some of their investment
offerings as wrap accounts (which received regulatory approval in September
2000). Only full-service securities companies can handle wrap accounts, which
must have at least W100m per personal account and W200m per corporate account.
At least 30% of assets on these accounts must be invested in high-yield bonds.
Cash management accounts (CMAs), a South Korean version of US money-market
mutual funds, pool funds from several investors. Investment in CMAs through
short-term financing houses requires an initial minimum deposit of W4m. Interest
is paid every six months. After the first deposit, no minimum deposit
requirement applies. Deposits may be withdrawn at any time, just as from
passbook accounts.
From January 2000 individual investors in South Korea have been allowed to
invest in offshore portfolio funds sold by domestic institutions and managed by
foreign asset-management firms, without paying tax on capital gains. Individual
investors were already exempt from taxation on capital gains from investment
trusts and mutual funds invested in domestic securities. The offshore funds are
supposed to invest in high-quality foreign securities and can be linked to
currency forward contracts with the Korea Development Bank to hedge against
foreign-exchange risk. This tax measure is designed to allow investors to
diversify investment risk globally and to allow local fund managers to learn
global asset-management know-how. In addition, increased global asset holdings
by the private sector are expected to help the government moderate or expand
foreign- exchange supply as the country's second set of foreign reserves.
South Korea's heavily regulated asset-management sector will undergo an
important round of deregulation under a government plan to enact a new
comprehensive law for the industry (see the boxed text on page 24).
New legislation aims to boost South Korea's asset-management sector
South Korea's heavily regulated asset-management industry will undergo major
deregulation under a government plan to spur a broad, long- term economic shift
to equities to meet future capital and investment needs. The legislation, which
was submitted to the National Assembly in November 2002 and is expected to take
effect sometime in 2003, aims to develop the local asset-management industry to
promote an equity-oriented element in the country's bank-dominated financial
system. It also aspires to improve rules and regulations to help meet the
challenge of a rapidly ageing population.
The South Korean asset-management industry remains heavily biased in favour
of bonds and other low-risk assets. According to the MOFE, a total of W249trn
was invested in local investment trusts, mutual funds and bank trust accounts at
end-June 2002, compared with W223trn at end-2000. The new law is expected to
boost the role of portfolio funds as long-term sources of stable demand for
stocks.
The plan, announced by the Ministry of Finance and Economy (MOFE) in August
2002, calls for the enactment of a new "asset management act" as
umbrella legislation covering the four existing laws on asset management- the
Securities Investment Trust Business Act, the Securities Investment Company Act,
the Trust Business Act and the Insurance Business Act. Another amendment will be
made to the Securities and Exchange Act to bring its asset-management
regulations in line with the new asset-management law.
The key features of the proposal are as follows:
* It will remove restrictions on portfolio allocation of assets under
management. Currently, portfolio investment of client assets is restricted to
marketable securities, commercial paper and exchange-traded derivatives. The new
law will expand portfolios to include real estate, commodity and
over-the-counter derivatives. It will put in place caps on risk exposure to
particular types of assets.
* It will allow insurance companies to sell investment funds. Currently, only
securities companies and banks are permitted to sell funds directly to
investors.
* It will ease reporting and disclosure requirements on private equity funds.
An easing of the application of the Commercial Code to mutual funds will make it
easier to establish and operate mutual funds. For example, investment companies
will be exempt from incorporation and annual shareholders' meeting requirements.
* It will require fund managers to issue statements to investors once every
three months instead of every six months, as currently required, and to disclose
on a timely basis any "significant" changes (such as changes in
prospectuses, fund managers, and asset pricing and quality). Regular statements
should include information on asset turnover, fund performance and management
fees. For added protection of investors, all funds will be required to receive
outside audits. The outside audit requirement currently applies only to trust
funds with assets valued at W10bn or more.
* It will introduce fund performance rating agencies as a new type of
securities business. Companies registered with the Financial Supervisory
Commission will specialise in measurement of fund performance.
2.5 Venture-capital & private-equity firms.
Venture capital made its debut in the late 1980s, and legislative support in
the following years laid the legal groundwork for the growth of local firms.
Especially after the financial crisis of 1997-98, the government began promoting
venture capital heavily in the hope of revitalising the economy, with many
technology-driven small companies as an augmentation to or even a substitute for
the local chaebol conglomerates. The Small and Medium Business Administration (SMBA)
and the Ministry of Information and Communication are the key government
agencies in charge of policy for the sector. The key industry association is the
Korea Venture Capital Association (KVCA). For all of these bodies, see the key
financial contacts list on page 74.
In South Korea, a venture-capital firm is legally defined as a joint-stock
company, capitalised at W10bn or more, that specialises in investment activities
for small and medium-sized companies (with a workforce smaller than 300
employees or equity capital not exceeding W8bn, or W3bn for non- manufacturing
firms). Target firms are classified as "venture companies" and must
meet at least one of the following conditions: at least 10% of equity capital
financed by venture-capital firms; research and development expenditures
exceeding 5-10% of sales, with at least W50m invested; or possession of strong
technology proven by patentability and transferability. As of end-November 2002
there were 9,106 venture companies registered with the SMBA.
Venture-capital firms must be registered with the SMBA and maintain certain
minimum investment requirements (20% of paid-in capital invested in venture
companies for two years after registration, for example) in return for various
tax incentives. The requirements for individual venture-capital funds include a
minimum investment capital of W200m (lowered from W500m in November 2002).
Top ten venture-capital firms
Ranked by paid-in capital at end-June 2002-W m
Company Capital
IBK Capital 55,452
Dasan Venture 50,665
Kookmin Venture 44,759
Korea Investment 38,899
TriGem Ventures 38,000
Hansol Capital Investment 32,500
Korea IT Venture Partners 32,200
Daeyang Venture Capital 30,250
Hyundai Capital 30,000
LG Venture Investment 30,000
Source: Korea Venture Capital Association.
According to the KVCA, 134 venture-capital firms and 417 venture-capital
funds were registered as of end-September 2002. IBK Capital, an affiliate of
Industrial Bank of Korea; Dasan Venture, an independent venture-capital firm;
and Kookmin Venture, a unit of Kookmin Bank, ranked among the top venture
capitalists. For a list of the country's top venture-capital firms, see the
table above.
In one of the major venture-financing deals of 2002, Pulsus Technologies, a
developer of digital audio-amplifier technology, received funding worth US$4.55m
in December from domestic and international firms, including US- based
private-equity firm Carlyle Group, Softbank (Japan) and STIC Venture (Korea).
The SMBA's latest survey of the venture-capital industry, released in January
2003, shows that investment fell to W565.2bn in 2002, from W889.3bn a year
earlier. Some 83% of the investments in 2002 were made by purchasing equity
stakes and equity-linked bonds. The decline in venture financing was largely
attributable to the continuing weakness of the Kosdaq (Korean Securities Dealers
Automated Quotations) market following the market's collapse in 2000 (8.1). A
stream of accounting and securities fraud cases involving venture companies also
contributed to the decline.
As part of an effort to reinvigorate the venture-capital market, the SMBA is
pushing for a legislative programme to allow venture capitalists to organise
limited-liability companies (as in the US) as opposed to joint- stock companies.
See the legislative watchlist on page 32.
Separate from the SMBA, the Financial Supervisory Commission (FSC) keeps its
own list of venture-capital firms for regulatory purposes. As of end- June 2002
six "venture-capital finance" firms were registered with the FSC, with
a combined W1.05trn in outstanding investment (including loans).
Top ten listed financial leasing companies
Ranked by sales in the period April 1st 2001 March 31st 2002-W m
Company Sales
KDB Capital 423,714
Korea Development Leasing 373,424
Korea Lease Financing 350,674
Citilease* 263,452
Hanvit Leasing & Finance 247,620
Daewoo Capital* 226,046
Kookmin Leasing* 204,704
Shinhan Capital 150,281
Sun Capital 138,871
C&H Capital 82,264
*Sales in 2001/2002.
Source: Company reports.
Venture capitalists shepherding companies to initial public offerings (IPOs)
on the Kosdaq market (8.1) are required to keep at least 10% of their stock
holdings during a six-month post-IPO lock-up period. A venture capitalist can
invest in foreign securities up to 30% of its shareholders' capital. The
government offers many tax incentives for individual and corporate investment in
venture-capital firms and funds, including tax exemption on capital gains.
An amendment to the Special Treatment Act for Nurturing Venture Businesses,
enacted in July 2002 and put into force on November 1st 2002, aims to boost
venture-capital financing by promoting strategic alliances and mergers between
venture companies. The revision allows a venture company to acquire its own
shares and swap treasury stock for shares in other venture companies as part of
a strategic alliance. Stocks can be swapped to the extent of 20% of the total
outstanding shares of the company. Furthermore, venture capitalists can now
invest in limited- liability venture companies.
Private-equity funds were not allowed until July 2000, when the FSC first
introduced regulations for them. According to the regulations provided by the
Securities Investment Trust Business Act, a private-equity fund should be a
long-term unit trust fund with a maturity period of at least one year and a
minimum capitalisation of W10bn, funded by fewer than 100 investors. The 10%
ceiling on investment in any single stock, which applies to investment-trust and
mutual funds (2.3) does not apply to private-equity funds, but investment in a
single stock is not allowed in excess of 50% of portfolio assets. Private-equity
funds specifically aimed at acquiring a controlling stake in a company are not
allowed to unwind their holdings within six months from acquisition
