Staying strong, bouncing back

South Korea has not escaped the financial crisis, but is perhaps better placed to ride out the recession than many other economies. A strong and well-regulated financial services sector can take much of the credit. But surprisingly, perhaps, some of the country's earlier defenses against financial excess are now being weakened. Won Duk Cho and Young Min Kwon say it is too early to forecast the consequences.

A decade before the current crisis, South Korea was overwhelmed by the Asian financial crisis of 1997. The collapse of the Thai Baht triggered a cascade of financial instability across the region which threatened the global economy. One of the hardest-hit countries, in part because of its reliance on foreign debt, Korea saw the value of the Korean Won (KRW) fall by a half and a number of major industrial conglomerates slide into insolvency. A third of domestic merchant banks closed down.

Complete disaster was avoided through an International Monetary Fund bailout, debt reconstruction and decisive action by the Korean government. Toxic assets were removed from financial services companies, regulation was strengthened and a much-enhanced risk management regime instituted by banks and insurers. Within 18 months, the economy had returned to substantial growth. A further crisis in 2003 followed reckless expansion of Korea's credit card sector. Once again, government intervention and restructuring contained the crisis, and subsequent legislation imposed much tighter controls on domestic credit.

Largely as a result of the measures taken following these crises, the Korean economy has remained sound, and has been robust enough to withstand the recent economic storms. Weak and risk taking institutions had already been closed down or restructured. Many domestic banks had limited exposure to structured products such as credit default swaps, and so have managed to avoid direct impact from the US sub-prime disaster. The government has in place very strong measures to curb speculative investment. Loan-to-value ratios on mortgage lending, for example, are limited by legislation to 40 to 60 percent depending on the location.

Over the last 12 months, there have been no major bankruptcies among financial services companies in Korea. Although some losses were reported in the first quarter of 2009, by quarter two profitability had returned, and the economy as a whole had returned to growth - GDP is up by more than two percent on a quarter-on-quarter comparison. Exports are improving, the KOSPI stock market index is recovering and the Won-US dollar exchange rate is strengthening.

Default rates on consumer debt remain low - remarkably so by international standards - ranging from 0.5 to 0.75 percent on mortgage and total debt respectively. Partly because of the earlier credit card crisis, the credit industry is traditionally very heavily regulated. The government acts in a very interventionist manner, prohibiting certain classes of financial product. Most consumer cards are charge cards, with balances being cleared monthly; the portion of revolving credit is limited.

As the global economy recovers from the crisis, the Korean government is keen to stimulate the development of larger and more globally-competitive financial services providers, capable of competing with the largest in the world. The sector is developing rapidly. Among current trends are:

Asset management
The asset management industry is growing very fast. Despite a setback during 2008, assets under management have grown rapidly since 2004. Current growth (29 percent) is among the highest in the world. Low interest rates are pushing savers and investors to look for higher returns from alternative investment. With a rapidly ageing population, the national and corporate pension sectors are also set for strong and continued growth. The funded national pension scheme has assets approaching US$200 billion.

In order to underpin the future development of the financial services sector, the Korean government has recently introduced the Financial Investment Services and Capital Markets Act (the Capital Markets Act).

Korea's capital market remains relatively small in comparison with the overall size of the economy. This new Capital Markets Act aims to improve capital availability, strengthen the capital markets and reduce regulation. It brings together into a single framework securities and futures trading, indirect investment, trust business, merchant banking and foreign exchange.

Ironically, the legislation was prepared largely before the full impact of the current crisis became apparent, and drew in part on the earlier regulatory approach of the UK's Financial Services Authority. To some extent, then, it represents a relaxation of the tight regulatory control which many credit with saving Korea from the worst impacts of the global market turmoil. Some influential voices in Korea are already arguing that these moves are inappropriate, and go against the tide of stricter regulation being introduced in the rest of the developed world. It remains to be seen whether abandoning some of the protection of the earlier model may threaten the Korean economy if and when it is tested by a future downturn.

Article authors

Won Duk Cho
Partner
KPMG in Korea +82 2 2112 0215 Won Duk Cho View all articles by this author

Young Min Kwon
Partner
KPMG in Korea +82 10 7705 3467 Young Min Kwon View all articles by this author