Economic Analytical Unit

Korea Rebuilds: From Crisis to Opportunity

Additional Material for Korea Rebuilds: from Crisis to Opportunity, Economic Analytical Unit, Department of Foreign Affairs and Trade, Canberra, May 1999.

Korean Economic Data Referred to in Chapters 7-9 of Economic Analytical Unit’s report

Chapter 7: Macroeceonomic Management

IMF Agreements with Korea, 1997-99

Table 7.1

IMF Stand-By Arrangement Summary of the Economic Program
Agreed by the Government of the Republic of Korea and the International Monetary Fund, 5 December 1997

Macroeconomic policies
Objectives	The program should narrow the external current account deficit to below 1 per cent of GDP in 1998 and 1999, contain inflation at or below 5 per cent, and if confidence is restored quickly, limit the deceleration in real GDP growth to about 3 per cent in 1998, so recovery can occur in 1999.
Monetary policy and exchange rate policy	To demonstrate to markets the authorities' resolve to confront the present crisis, tighter monetary policy should restore and sustain calm in the markets and contain the impact of the recent won depreciation on inflation. In line with this policy, the large liquidity injection has been reversed, and the call rate was raised from 12.5 per cent on 1 December 1997 to 21 per cent, and will be raised further. Money growth during 1998 will be limited to a rate consistent with containing inflation at or below 5 per cent. A flexible exchange rate policy will be maintained, with intervention only limited to smoothing operations.
Fiscal policy	A tight fiscal policy in 1998 should alleviate the burden on monetary policy and provide for the still uncertain costs of restructuring the financial sector. The cyclical slowdown is projected to worsen the 1998 budget balance of the consolidated central government by about 0.8 per cent of GDP. The present estimates of the interest costs of financial sector restructuring is 0.8 per cent of GDP. Offsetting measures amounting to about 1.5 per cent of GDP will be taken to achieve a balanced budget and, preferably, a small surplus. This should be achieved by both revenue and expenditure measures including: increasing VAT coverage and removing exemptions widening the corporate tax base by reducing exemptions and certain tax incentives widening the income tax base by reducing exemptions and deductions increasing excises, luxury taxes, and transport tax reducing current expenditures particularly support to the corporate sector reducing low priority capital expenditures.
Financial sector restructuring
Financial sector reform bill	The following financial sector reform bills submitted to the National Assembly will be passed before the end of 1997: a revised Bank of Korea Act, which provides for central bank independence, with price stability as its main mandate a bill to consolidate supervision of all banks, including specialised banks, merchant banks, securities firms, and insurance companies in an agency with operational and financial autonomy, and with all powers needed to deal effectively with troubled financial institutions a bill requiring that corporate financial statements be prepared on a consolidated basis and be certified by external auditors.
Restructuring and reform measures	Troubled financial institutions will be closed, or if they are deemed viable, restructured and/or recapitalised. The government already suspended nine insolvent merchant banks on 2 December 1997. These banks are have been placed under the control of MOFE and must submit a rehabilitation plan within 30 days. These plans will be assessed in consultation with Fund staff and, if not approved, the institution will have its licence revoked. A credible and clearly defined exit strategy includes closures as well as mergers and acquisitions by domestic and foreign institutions, providing new groupings are viable. Clear principles will be established on how losses will be shared among equity holders and creditors. The disposal of non-performing loans will be accelerated. Blanket guarantees which will end in three years will be replaced by a limited deposit insurance scheme. A timetable will be established for all banks to meet or exceed Basle standards. Prudential standards will be upgraded to meet Basle core principles. Any support to financial institutions will be strictly conditional. All support to financial institutions, other than Bank of Korea liquidity credits, will be provided according to pre-established rules, and recorded transparently. Accounting standards and disclosure rules will be strengthened to meet international practice. Financial statements of large financial institutions will be audited by internationally recognised firms. Staffing in the unit supervising merchant banks will be sufficiently increased to make supervision effective and allow proper handling of troubled banks. The schedule for allowing foreign entry into the domestic financial sector will be accelerated, including allowing foreigners to establish bank subsidiaries and brokerage houses by mid -1998. Borrowing and lending activities of overseas' branches of Korean banks will be closely monitored to ensure that they are sound. Nonviable branches will be closed. The Bank of Korea’s international reserve management will be reviewed to bring it closer to international practice. Deposits with overseas branches of domestic banks will not be increased further, but gradually withdrawn as circumstances allow. Financial institutions will be encouraged to improve their risk assessment and pricing procedures, and to strengthen loan recovery; actions in these areas will be reviewed as part of prudential supervision.
Other Structural Measures
Trade liberalisation	Timetables complying with the WTO commitments, will be set at the first review to: eliminate trade-related subsidies eliminate restrictive import licensing eliminate the import diversification program streamline and improve the transparency of the import certification procedures.
Capital account liberalisation	The present timetable for capital account liberalisation will be accelerated by taking steps to: liberalise foreign investment in the Korean equity market by increasing the ceiling on aggregate ownership from 26 per cent to 50 per cent by the end of 1997 and to 55 per cent by the end of 1998. The ceiling on individual foreign ownership will be increased from 7 per cent to 50 per cent by the end of 1997 effective immediately, the supervisory authority will allow foreign banks to purchase equity in domestic banks in excess of the 4 per cent limit requiring supervisory authority approval, providing such purchases contribute to the efficiency and soundness of the banking sector; legislation will be submitted to the first special session of the National Assembly to harmonise the Korean regime on equity purchases with OECD practices (with due safeguards against abuse of dominant positions) allow foreign investors to purchase, without restriction, domestic money market instruments allow unrestricted foreign investment in the domestic corporate bond market further reduce restrictions on foreign direct investment through simplifying procedures eliminate restrictions on foreign borrowings by corporations.
Corporate governance and corporate structure	By the first review, the timetable will be set to improve the transparency of corporate balance sheets, including profit and loss accounts, by enforcing accounting standards in line with generally accepted accounting practices, including through: independent external audits full disclosure provision of consolidated statements for business conglomerates. The commercial orientation of bank lending will be fully respected, and the government will not intervene in bank management and lending decisions. Remaining directed lending will be eliminated immediately. While policy lending (such as to agriculture and small business) will continue, the interest subsidy will be borne by the budget. Government subsidised support or tax privileges will not be provided to bail out individual corporations. The 'real name' system in financial transactions will be maintained, although possibly revised. Measures will be worked out and implemented to reduce the high debt-to-equity ratio of corporations, and capital markets will be developed to reduce the share of bank financing by corporations. These will be reviewed as part of the first program review. Measures will be worked out and implemented to change the system of mutual guarantees within conglomerates, thereby reducing the risk involved.
Labour market reform	The capacity of the new employment insurance system will be strengthened to facilitate the redeployment of labour, in parallel with further steps to improve labour market flexibility.
Information provision	Data will be published regularly on foreign exchange reserves, including the composition of reserves and net forward position with a two weeks delay initially. Data on financial institutions, including non-performing loans, capital adequacy, and ownership structures and affiliations will be published twice a year. Data on short-term external debt will be published quarterly.

Source, IMF, 1997, 'Republic of Korea - Standby Arrangement, Letter of Intent', www.imf.org .

Government Finances

Table 7.2

Government Spending Increases as Share of GDP
Central Government Expenditure, Share of GDP (Won billion and Per cent)

		1990		1991		1992		1993		1994		1995		1996		1997
Expenditure (growth rate)		27 437 (20.5)		31 284 (14.0)		33 362 (6.6)		37 268 (11.7)		42 795 (14.8)		51 498 (13.6)		58 480 (13.6)		63 962 (9.4)
General administration		2 811		3 500		4 174		4 454		4 760		5 453		6 282		6 821
National defence		6 856		7 961		8 625		9 158		10 128		11 368		12 945		13 653
Education		5 586		5 549		6 463		7 397		8 241		9 738		11 030		12 068
Social development		2 450		3 179		3 235		3 417		3 860		4 163		5 021		5 899
Economic development		3 868		5 136		6 216		7 696		9 875		11 507		13 123		16 281
Subsidy for local government		2 765		3 452		3 928		4 368		4 770		5 484		6 378		6 799
Repayment of debt and others		3 110		2 506		726		778		1 160		3 784		3701		1445
General government account to GNP ratio		25.0		26.1		27.2		27.8		29.8		28.8		30.2		35.0
Central government account to GNP ratio		18.2		18.4		18.4		19.3		20.5		20.9		21.7		23.6
Local government Account to GNP ratio		6.8		7.7		8.8		8.5		9.3		7.9		8.6		11.4
Share of government debt to GDP

Source: Ministry of Finance and Economy, 1998, Korea's Economic Reform, Progress Report, Seoul.

Table 7.3

Defence Spending Falling; Economic Service Spending Rising
Classification of Central Government Expenditure (Won billion, Per cent)

	General administration	Defence, public order and safety	Education	Health	Social securityand welfare	Housing and community amenities	Other community and social services	Economic services	Unallocable and other purposes	Total
										Amount	Share
1990	8.5	20.0	17.0	1.7	8.1	10.1	0.5	20.4	13.7	3 329.6	100
1991	8.8	19.6	13.9	1.8	8.5	9.2	0.5	20.7	17.0	4 031.2	100
1992	9.8	19.3	14.4	0.9	9.3	7.2	0.5	18.7	19.8	4 499.3	100
1993	9.8	19.3	14.4	0.9	9.3	6.2	0.6	19.9	19.4	4 499.3	100
1994	11.3	18.2	13.9	0.8	9.3	6.1	0.6	25.4	15.6	6 012.5	100
1995	11.2	18.2	19.2	1.8	8.3	11.9	0.43	31.6	-3.2	9 048.2	100
1996	10.6	16.7	18.5	2.1	9.0	12.8	0.31	28.9	0.04	10 747.4	100

Source: Ministry of Finance and Economy, 1998, Korea's Economic Reform, Progress Report, Seoul.

Table 7.4

Many Small National and Local Taxes
Sources of National and Local Taxation Revenue, 1996

	National Taxes	Proportion of total taxation revenue	Local Taxes
	Total National	81.4	Proportion of total tax 18.6
Direct Taxes (42.1)	Income tax Corporation tax Excessively increased value of land tax Inheritance tax Excess profit tax Assets revaluation tax	24.4 15.5 0.0 1.9 - 0.3	Acquisition tax Registration tax Licence tax Inhabitant tax Property tax Automobile tax Farmland tax Butchery tax Aggregate tax
Indirect Taxes (37.4)	Value added tax Special consumption tax Liquor tax Telephone tax Securities transaction tax	32.1 5.0 - - 0.4	Horse race tax Tobacco consumption tax
Earmarked Taxes1	Education tax Transport tax	- 9.5	City planning tax Community facility tax Workshop tax Regional development tax

Note: 1 is revenue from earmarked taxes which is invested in social and economic infrastructure.

Shares of categories in total tax are given for national tax only.
Source: Ministry of Finance and Economy, 1998, Korea's Economic Reform, Progress Report, Seoul.

Chapter 8: Financial Market Management and Reform

Activities of the Korea Asset Management Corporation

The Korea Asset Management Corporation will purchase non-performing loans with Won 32.5 trillion of public funds, raised by issuing Non-performing Loan Management Fund Bonds, NPLMFB (Table 8.1). The Korea Deposit Insurance Corporation will also issue bonds.

Table 8.1

Government Plans to Complete Disposal NPLs by March 1999
Disposal Schedule for Non-Performing Loans and Recapitalisation (trillion won)

	Nov 97 -Aug 98(a)	Sep 98	Oct 98 - Dec 98(b) (est)	1st half 1999 (c) (est)	Total
Financed by Korea Asset Management Corporation Bonds
Non-performing loans purchased (i)	16	23	30 (d)	17 (d)	86 (d)
Purchase price (ii)	8.6	9.1	9.8	5.0	32.5
Purchase ratio (per cent)	54 %	40 %	33 %	29 %	38 %
Financed by Korea Deposit Insurance Corporation Bonds
Recapitalisation (iii)	1.5	4.9	3.1	-	9.5
Compensation (iv) (e)	-	7.0	-	-	7.0
Deposit insurance (v)	6.6	-	1.9	6.5	15.0
Total Costs (ii+iii+iv+v)	16.7	21.0	14.8	11.5	64.0

Notes: The figures are for all commercial banks including Seoul Bank, Korea First Bank, and all merchant banks, and fidelity/surety insurance companies.

The figures are for specialised banks, some sound banks, merchant banks, securities companies, and trust companies

The figures are newly realised non-performing loans.

Assumes the higher end of the Won 76-86 trillion range estimated by Government.

Compensation payment for loss coverage in purchase and assumption operations. It is the difference between assumed liabilities and assets acquired following purchase and acquisition of 5 closed banks and 4 insurance companies dealt with in late 1998.

Source: Ministry of Finance and Economy, 1998, ‘The Year in Review, Korea’s Reform Progress’, MOFE, Seoul.

The Government guaranteed Korea Asset Management Corporation bonds usually have a 3 to 5 year maturity and either fixed of floating coupon rates. These bonds are issued directly to banks and other financial institutions in exchange for non-performing loans. Recipient financial institutions are required to hold NPLMFB bonds for several (3-5) years before they can be sold on the open market, to prevent markets being swamped with Government bonds. The banks’ holding on NPLMFB bonds will also add to their Tier 1 capital, boosting their capital adequacy ratios.

Factories are largest the collateral asset category the Korea Asset Management Corporation has acquired through its purchases (Table 8.2).

Table 8.2

Factories Korea Asset Management Corporation’s Biggest Assets
Korea Asset Management Corporation’s Portfolio of Secured Non-performing Loans, September 1998

Collateral Type	Number of Properties	Proportion by Numbers( per cent)	Proportion by Appraisal Value( per cent)
Residential	1,340	51	12
Commercial	312	12	14
Land	201	8	12
Factories	624	24	46
Others	132	5	16

Source: Ministry of Finance and Economy, 1998, ‘The Year in Review, Korea’s Reform Progress’, MOFE, Seoul.

In the beginning, the purchase prices paid by Korea Asset Management Corporation for non-performing loans were very generous, offering 75 per cent on substandard, 20 per cent on doubtful and 3 per cent on expected losses. However, the Corporation has cut the price paid for non-performing loans on several occasions and is currently offering 45 per cent on substandard collateralised loans and 1-3 per cent on unsecured loans. The average has fallen to 38 per cent of loans’ face value.

The majority of non-performing loans acquired by Korea Asset Management Corporation are currently under court protection or court restructuring proceedings. The two non-performing loans types are ordinary non-performing loan whose assets are currently in default and on which debtors are making no payments and special non-performing loans whose assets are under court protection or in restructuring proceedings. The final price adjustments paid for the latter is contingent on the outcome of these proceedings. In disposing of the non-performing loans, Korea Asset Management Corporation’s strategy is to pool, and possibly securitise acquired assets to improve their value and marketability hence maximising returns on assets. The action programs to achieve this goal include:

• selling lower value non-performing assets through court auctions
• selling asset backed securities in the international capital market to secure cash from its collateral
• retaining potential gains through debt equity swaps or the Real Estate Investment Trust.

The ultimate goal is to dispose of the non-performing loans for at least their purchase price and distribute any profits to contributors (mainly the taxpayer).

In October 1998, at its first international auction Korea Asset Management Corporation sold about Won 208 billion of unsecured non-performing loans to Goldman Sachs. This was followed in December with a successful auction of Won 201 billion of real estate secured non-performing loans for 36 per cent of the outstanding principal balance to a US based real estate firm, Lone Star Fund. The purchased asset portfolio comprised loans secured on about 1,500 individual residential, commercial and other properties throughout Korea, bought by Korea Asset Management Corporation from Korean financial institutions.

Korea Deposit Insurance Corporation

The Korea Deposit Insurance Corporation’s new deposit insurance system divides deposits into three categories: protected, temporarily protected until the year 2000 and not protected.

• For accounts below Won 20 million, the Korea Deposit Insurance Corporation will guarantee the principal plus interest at a rate up to the prevailing one-year time deposit rate.
• For accounts of Won 20 million or more, the Corporation will only guarantee the principal for accounts opened or deposits made after 1 August 1998. For deposits made prior to then, both principal and interest are guaranteed.
• Certain short-term maturity instruments, such repurchase agreements issued by banks and securities houses after 25 July 1998 and fidelity/surety insurance policies entered into after 1 August 1998 are not insured.

Since the onset of the crisis, the Korea Deposit Insurance Corporation also has become responsible for recapitalising inadequately capitalised financial institutions. By late 1998, the Corporation has used Won 4.9 trillion of public funds to assist two nationalised banks (Korea First and Seoul), five acquiring banks (Kookmin, KHB, Shinhan, Hana, KorAm) and 3 merged banks (Commercial Bank of Korea, Hanil, Boram). Of the Won 4.9 trillion, Won 3.3 trillion was spent assisting the merger of Commercial Bank of Korea and Hanil Bank. All 8 banks’ capital adequacy ratio will be above 10 percent after recapitalisation.

An additional Won 7 trillion was paid to banks and life insurance companies to cover their losses in assuming the liabilities and assets of closed banks and life insurance companies through purchase and assumption transactions. Won 5.8 trillion was paid to 5 acquiring banks and Won 1.2 trillion was paid to 4 acquiring life insurance companies. As the Korea Deposit Insurance Corporation is a new institution, the bulk of its funds do not come from deposit insurance premiums, but from bond issues and borrowing from financial institutions (Table 8.3). To date all Korea Deposit Insurance Corporation bonds have been bought by the Bank of Korea (Won 6.5 trillion) and financial institutions (Won 1.6 trillion).

Table 8.3

Bonds and Borrowings Main Fund Sources
Korea Deposit Insurance Corporation Funding,
August 1998 (Won trillion)

Funding Source	Amount
Deposit Insurance Premiums	3.2
Korea Deposit Insurance Corporation Bonds	8.1
Borrowing from Financial Institutions	7.0
Others	1.4
Total	16.8

Source: Ministry of Finance and Economy, 1998, ‘The Year in Review, Korea’s Reform Progress’, MOFE, Seoul.

Post-crisis Bank Sector Rationalisation

Several large banks have merged as a result of the crisis, transforming the banking sector.

The Commercial Bank of Korea and Hanil Bank Merger

As of February, 1999, Commercial Bank of Korea and Hanil Bank merger was the biggest merger.

Table 8.4

Merger of CBK and Hanil Creates Korea’s Largest Bank
Merged Bank’s Status at 30 June 1998 (Won billion)

	CBK	Hanil	Hanvit (Total)
Total Assets	50 040	55 100	105 140
Total Equity	1 989	2 102	4 091
Total Deposits	25 773	27 167	52 940
Total Loans	28 163	34 679	62 843
Total Staff	7 810	7 492	15 302
Capital Adequacy Ratio	1.81	4.53	11(a)

Note: a is Estimated ratio at end 1998.

Source: Korea Herald Business News, 14 January 1999.

The Government spent Won 5.3 trillion recapitalising the merged Hanvit Bank, raising its capital adequacy ratio rose to 11 per cent by the end of 1998. Korea Asset Management Corporation purchased about Won 4 trillion of non-performing loans from the merged bank for around Won 2 trillion and the Government has injected Won 3.3 trillion into the bank in the form of Korea Deposit Insurance Corporation bonds. Due to the Government’s fiscal support, Hanvit was automatically nationalised as the Government’s equity share rose to around 95 per cent. To expedite the merger, the Financial Supervisory Commission ordered CBK and Hanil to reduce there capital by 90 per cent -effectively this meant that every 10 shares in each bank was converted to one share so that the merged banks capital was reduced from around Won 1.8 trillion to Won 180 billion.

Some commentators have expressed doubts about the success of the merger, with concern the union of Korea’s largest banks with different corporate cultures could falter because of internal disagreements (Korea Times, January 1999). Management improvement, independence from policy loans, and new foreign capital will be very important to fully rehabilitate the merged bank. Hanvit sees itself becoming Korea’s leading bank by 2002, and with increasing competitiveness playing a larger role in Asia by 2003 (www.cbk.co.kr).

Other Mergers

Kookmin Bank, which took over Daedong Bank in June 1998 and then merged with the Korea Long-term Credit Bank has created another meg-bank with assets of nearly Won 100 trillion. Kookim’s capital adequacy ratio was around 10 per cent at the end of 1998, compared to 12 per cent mid year. The Kookmin- Korea Long-term Credit Bank merger was seen as beneficial, combining Kookmin’s strong retail base with Korea Long-term Credit Bank’s corporate finance skills. In theory, the merger should maximise synergy and minimise layoffs because the two banks have little in the way of overlapping operations. However, the merged bank’s operations may be heading in the wrong direction with some reports suggesting the new bank will specialise solely in retail banking, raising concerns that its wholesale banking skills will be discarded over the longer term.

Korea’s third largest bank is likely to emerge from the merger of ChoHung, Kangwon and Hyundai Merchant banks. If successful, the merged bank will have assets of over Won 60 trillion.

Housing and Commercial Bank, which acquired Dongnam last year, estimated its BIS ratio at 10 per cent at end 1998. Shinhan Bank, which acquired the severely undercapitalised Donghwa Bank estimated its BIS ratio at 13.1 per cent at end 1998, while Koram Bank, which took over the regional Kyungi Bank estimated its capital adequacy ratio at 14.5 per cent at end 1998. Its merger with Boram it will create the seventh largest bank in terms of total assets, but still too small to be considered a leading bank. Thus, over the medium-term it is possible the Hana/Boram merged bank will seek another partner from among the remaining non-merged commercial banks.

Restructuring Non-viable Non-bank Financial Institutions

Merchant Banks

Prior to December 1997, 30 merchant banks operated in Korea in a wide range of business activities, including limited deposit and credit, trusts, securities, international financing and leasing. In the 1990s, the merchant banks' borrowed heavily in off-shore markets and lent in won, often extending unsecured loans to the chaebol. Their difficulties commenced when the Hanbo group, a large borrower from the merchant banks, declared bankruptcy in March 1997. The bankruptcy of Hanbo was followed by the failure of several other conglomerates and numerous small-and medium-sized firms. Each major bankruptcy further eroded international financial institutions' confidence in the Korean economy and the merchant banks, exacerbating the merchant banks' borrowing difficulties at home and abroad.

The Government suspended 14 insolvent merchant banks in December 1997. Subsequently, all 30 merchant banks were required to submit rehabilitation plans to the Merchant Bank Rehabilitation Plan Evaluation Committee, established on December 29, 1997. This committee audited all merchant banks and assessed their rehabilitation plans in consultation with the IMF and the World Bank. The first evaluation of the rehabilitation plans was based on whether a merchant bank could maintain a capital adequacy ratio above 4 percent. The second evaluation concerned capital adequacy, quality of assets, liquidity, management strategies and legality of activities.

Based on the Committee's assessment reports, the licenses of 12 merchant banks were revoked, followed by a further four by mid 1998. The Government is monitoring the remaining merchant banks to ensure they improve their management and reach the 8 per cent BIS capital adequacy ratio.

The bridge bank, Hannarum Merchant Bank, to which the assets and liabilities of all closed merchant banks were transferred, was established with funding from the Credit Management Fund.

Insurance Companies

At the end of 1997, the insurance industry comprised 21 domestic life insurance companies, seven joint ventures with foreign insurance companies and five subsidiaries of foreign life insurance companies. The non-life insurance industry had 11 domestic direct non-life insurers, two fidelity and bond insurance companies (credit guarantee insurance companies), and a single reinsurance company. Since late 1997, small and medium-sized life insurers have been experiencing liquidity difficulties largely due to a loss of confidence in their creditworthiness and insufficient solvency margins

In August 1998, the Financial Supervisory Commission announced restructuring measures for 22 insurance companies that had earlier submitted rehabilitation plans. Four life insurance companies were ordered to close. Their assets and liabilities will be taken over by solvent insurance companies after due diligence reviews are completed. Acquiring insurance companies estimate that purchasing the non-performing assets of these four life insurance companies would require 4 billion won. The Government estimates that 1.2 trillion won of public funds will be required to meet the net liabilities of the closed insurance companies, of which Won 0.9 trillion was injected by end of September 1998. Purchases and acquisitions may be delayed until these differences are resolved.

At the end of 1998, seven of the remaining insurance companies reported a combined net capital deficit (difference between total assets and liabilities) of 2.5 trillion won. The Financial Supervisory Commission is evaluating the assets of these insurers. The Government is closely monitoring the other sixteen insurance companies and by March 1999 plans to name other non-viable firms that will have to close or merge.

Other Non-bank Financial Institutions

Most of Korea’s 32 securities companies have reported net losses for the past three years, mainly due to the weak stock market and rising operating and financial expenses. Among these 32 companies, four have been determined unsound, two of which have been liquidated while two others are undergoing rehabilitation. The new capital adequacy requirement for securities companies will force some inefficient securities firms to exit, protect investors and improve the safety and stability of the securities industry.

Investment trust companies and investment management companies also have suffered from weak stock and bond markets, causing unrealised capital losses on the securities accounts. The high bond yields at the end of 1997 also encouraged many investors to redeem their beneficiary certificates, seeking higher interest rates elsewhere. In response, the investment trust companies borrowed heavily short-term to redeem the bonds, which they were unable to sell in the market. The resulting large debt and huge interest payments aggravated the situation for investment trust companies. At end-1997, investment trust companies’ interest payments were estimated to be as big as the sum of management fees and performance fees for most investment trust companies. As of May 1998, investment trust companies had an aggregate negative asset value of Won 4.2 trillion.

As investment trust companies continue to guarantee returns they are unable to realise on their own investments, their losses continue to accumulate. However, so far investment trust companies have undergone less restructuring than other financial institutions because the Government is concerned about the destabilising effect on the economy of liquidations in this sector. So far, the authorities have revoked the license of one investment trust company (Hannam) and another is currently under suspension. Additionally, one investment trust management company has dissolved of its own accord and five others are seeking dissolution.

The leasing industry was a major source of funds for the chaebols and hence has been in difficulty since the mid 1990s. Increased competition and continuing economic recession resulted in decreased profits, increased non-performing lease assets and losses in security investments. Among 25 leasing companies the Financial Supervisory Commission ordered 10 to either liquidate or be acquired, depending to decisions made by their major shareholders. The assets and liabilities of companies under liquidation are transferred to the Korea Non-Bank Lease Financing Company, a bridge leasing company established in July 1998.

Out of 230 mutual savings and finance companies, the Non-Bank Supervisory Authority has imposed management control measures on 20 companies and management guidance measures on 11 companies, with the goal of inducing rehabilitation. Those companies deemed incapable of recovery will be closed, either through a business transfer, sale or liquidation. A bridge company specifically created to manage the closure procedures for mutual savings and finance companies was established in September 1998. In addition, 12 credit unions were designated for closure and 27 credit unions became subject to management guidance measures.

Chapter 9: Corporate and competition policy

Table 9.1

Corporate Debt Explodes in 1997
Corporate Debt (Won trillions)

	1996	1997	June 1998a
Corporate debt - Domestic loans - Short term bonds - Long term bonds - Overseas loans - Government loans	270 69 129 30 4	338 74 171 54 7	334 73 186 42 na
Subtotal	502	644	634
Corporate financial assets - Deposits and other assets - Short term bonds - Long term bonds	117 18 23	137 14 29	159 7 29
Subtotal	158	180	195
Net debt	344	464	439

Note: June 1998 data are unofficial estimates provided by the Financial Services Commission.

Source: Ministry of Finance and Economy, 1998, ‘Reference Information for the Korea Forum’, Seoul; Financial Services Commission, 1999, ‘Corporate Restructuring; Progress to Date and Agenda Ahead’, Seoul (in Korean).

Table 9.2

First Steps to Achieve Restructuring
Policy Framework and Strategies

Policy Framework
Step 1	Planning corporate restructuring policies and implementing schedules (May 1998)
Step 2	Roughly analysing ‘triages’ to prevent bankruptcies of viable companies from the credit crunch, caused by the effective failure of financial intermediation (June 1998)
Step 3	Encouraging voluntary corporate workout programs with the help of advisory groups (ongoing)
Step 4	Implementing full scale chaebol restructuring including the top 5 chaebol (started)
Strategies
5 Biggest Chaebol		Focus on enhancing long term competitiveness rather than short term liquidity Drive restructuring plan using major creditors’ council to increase bank negotiation powers Revise chaebol Capital Structure Improvement Plan, which already have been submitted . Revisions must contain a specific and feasible restructuring plan Accommodate voluntary restructuring plans of the chaebol in the final chaebol-wide restructuring plan Ensure the ‘big deal’ proposal is just one part of a restructuring plan focused on core competencies
6 to 64 biggest chaebol		Ensure major creditor financial institutions undertake financial restructuring of distressed corporations Derive optimal corporate workout plans using voluntary negotiations between financial institutions and corporations Ensure financial institutions agree upon set fair game rules for the workout process
Small and Medium Enterprises		Triage analysis in June: establish first priority for support (35.4 per cent), conditional support (58.2 per cent) and others (6.4 per cent) Implement workout process for conditional support category Facilitate Corporate Restructuring Fund for small restructuring: Won 1.1.trillion for debt fund, Won 0.5 trillion for equity fund.

Source: Ministry of Finance and Economy, 1998, ‘Reference Material for the Seoul Forum’, Seoul.

Table 9.3

A Changed Legislative Framework
Amendments to Government Legislation

Article	Changes
External Audit Law	Revised to mandate combined financial statements; now operating. External auditors and corporate accounting officers now are subject to stiffer penalities, while the Auditor Nomination Committee must approve the appointment of internal auditors for listed companies and chaebol affiliates.
Securities Exchange Law	The following rules were abolished to facilitate mergers and takeovers: statutory tenders could only offer for 25 per cent of shares, and could be required to purchase over 50 per cent; only the largest incumbent shareholder could acquire more than 10 per cent of the stocks of a listed company. Strengthened regulations requiring companies to reveal financial transactions with their controlling shareholders (a public disclosure requirement similar to the US Williams Act of 1968). Minority shareholder rights are stronger, lowering the minimum number of shares to be held for shareholder derivative suits from 1 per cent to 0.05 per cent (0.5 per cent for companies with net assets below W100 billion). This minimum was lowered again down to 0.01 per cent on 15 May 1998. The floor to request dismissal of directors was lowered from 1 per cent to 0.25 per cent (0.5 per cent for smaller companies). The floor for the right to inspect and transcribe corporate accounts was lowered from 3 per cent to 0.5 per cent (1 per cent for smaller companies). The ceiling for buyback of a company's own stocks was raised initially from 10 per cent to 33 per cent, before being abolished. The procedure for merging listed and unlisted affiliates was simplified.
Listing Requirements for the Korean Stock Exchange	From 1999, all company boards must include outside directors and at least one-quarter of the members of the board of a listed company must be outside, independent directors.
Securities Investment and Trust Law	Amended on September 2, 1998 to abolish the shadow voting regulation, allowing institutional investors to freely the exercise their voting rights.
Securities Investment Company Law	The Corporate Restructuring Fund was capitalised in October 1998 with Won 1.6 billion to improve the financial status of small and medium sized enterprises through equity investment and debt rescheduling.
The Banking Act	The ceiling on bank’s equity investment in individual corporations rose from 10 per cent to 15 per cent of the corporation's outstanding stocks.
Foreign Capital Inducement Act	Hostile takeovers by foreigners were liberalised. The requirement for prior approval by the Minister of Finance and Economy was abolished for large scale mergers and acquisitions in all sectors, except parts of the defence industry. Government now allows foreign direct investment in almost half of the 48 business lines. The ceiling on total foreign shareholdings in individual companies was abolished in May 1998.
Monopoly Regulation and Fair Trade Act	The ceiling on equity investments by chaebol affiliates was abolished and new debt payment guarantees among chaebol affiliates are prohibited and existing debt guarantees must be eliminated by the end of March 2000. The law is being revised to allow pure holding companies to be established under a set of restrictive conditions.
Guidelines on Credit Management by Financial Institutions	Prohibits financial institutions from demanding debt payment guarantees by affiliates.
Corporate Tax Law	Interest payments for debts exceeding five times equity capital are not to be classified as allowances, effective in 2000, two years earlier than originally planned.
Corporate Reorganisation Law	Criteria is to be introduced comparing the scrap value of a company with its going-concern value; this will be used in court evaluations of applications for reorganisation. The amended law also simplified reorganisation procedures by facilitating the consolidation of related cases under the same court, shortening the deadlines for the approval and submission of reorganisation plans to between 12 and 18 months and reducing the grace period of debt repayment from 20 to 10 years. This law established the Reorganisation Management Committee to advise the court and major creditors.
Corporate Composition Law	Conditions for mutual settlement between a corporation and its creditors specify those cases in which such a deal is undesirable. They also restricts unfeasible applications for composition and strengthen monitoring of mutual settlements. The procedures of the composition law were simplified and procedural exemptions for small and medium sized firms were introduced.
Commercial Code of Korea	Revised substantially to improve corporate governance. Amendments include: Made de facto directors (controlling shareholders or those who influence the decisions of the board of directors) as accountable and liable as the registered directors Strengthened the fiduciary duty of corporate directors by newly introducing their duty of loyalty which reinforces the previous duty of care Strengthened shareholders rights in line with those provided in the Securities Exchange Law Introduced cumulative voting system in the appointment of directors Introduced the right of shareholder proposal Lowered the minimum nominal value of a stock from five thousand won to one hundred won Introduced corporate spin-offs Simplified the procedure for corporate mergers.

 Table 9.4

Korea’s Titans
Data on the 30 Largest Chaebol, July 1997 (Won billion, Per cent)

	Total Assets	Equity-assets ratio	Paid-in equity capital	In-group share-holding ratio	Totala sales	Number of affiliates	Number of listed sub-siduaries	Number of 3-digit KSIC industries participating	Number of financial affiliatesb
1. Hyundai	59 325	17.9	3 891	65.2	69 798	57	20	39	5
2. Samsungc	82 438	17.9	4 202	46.7	75 605	80	16	31	5
3. LG	45 482	21.1	3 593	40.1	48 635	49	11	28	2
4. Daewoo	37 497	24.1	4 316	38.3	38 620	30	10	26	6
5. SK	23 998	20.4	1 208	44.7	26 797	46	6	26	2
6.Ssangyong	18 305	20.5	1 317	42.0	20 157	25	11	32	3
7. Hanjin	17 594	14.3	923	41.4	9 972	24	9	26	3
8. Kia	14 508	16.3	1 099	30.6	12038	28	6	17	1
9. Hanwha	14 388	11.3	1 040	33.0	10 088	31	7	26	4
10. Lotte	7 925	33.8	1 440	22.8	7 209	30	4	22	3
11. Kumho	8 551	15.4	1 028	40.1	4 834	26	4	19	1
12. Halla	6 657	4.8	294	49.5	5 297	18	4	17	1
13. Dongah	8 873	13.2	451	54.2	5 416	19	4	15	1
14. Doosan	6 402	12.6	324	49.7	4 046	25	8	27	2
15. Daelim	6 810	21.2	412	34.2	4 970	21	5	19	1
16. Hansol	6 431	18.8	560	37.3	2 700	23	7	16	2
17. Hyosung	6 131	21.3	253	44.9	5 478	18	2	16	0
18. Dongkuk	6 764	21.0	316	51.0	3 487	17	7	16	0
19. Jinro	3 881	2.7	281	45.8	1 391	24	4	16	5
20. Kolon	4 638	20.5	442	45.1	4 471	24	4	21	3
21. Kohap	3 810	14.7	371	39.4	2 563	13	3	11	0
22. Dongbu	6 233	17.6	385	47.8	4 856	34	6	18	0
23. Tongyang	9 558	13.6	580	50.1	3 602	24	4	17	2
24. Haitai	3 398	13.2	207	30.9	2 716	15	3	12	0
25. Newcore	2 803	7.6	121	98.7	2 279	18	0	7	0
26. Anam	2 792	17.1	295	42.0	1 995	21	2	15	4
27. Hanil	2 599	14.8	293	37.4	1 277	7	2	14	0
28. Kupyung	4 963	14.0	277	59.0	1 387	22	5	19	4
29. MiWon	2 235	19.4	258	52.5	2 116	25	5	15	2
30. Shinho	2 237	17.0	298	36.9	1 223	25	6	11	2
Total/average	425 226	18.2d	30 475	43.0d	385 023	819	185	19.8d	64

Note: a is 1996; b is as of April 1993; c is average; d assets and sales quoted in this table include those of financial affiliates. The Fair Trade Commission ranks Hyundai largest as it has most assets excluding financial affiliates.

Source : Fair Trade Commission, 1997, ‘Stock Holdings of 30 Largest Business Groups’, July 2 Press release (in Korean).

Table 9.5

Cross Shareholdings Account for One-Third of Chaebol Capital
 Chaebol’ In-Group^a Ownership Concentration

		1983	1987	1989	1990	1991	1992	1993	1994	1995	1996	1997	1998
Top 30 Chaebol		57	56	46	45	47	46	43	48	43	44	43	45
Family		17	16	15	14	14	13	10	10	11	10	9	na
Affiliates		40	40	32	32	33	34	33	33	33	34	35	na
Top 5 Chaebol		naa	60	49	50	52	52	49	48	na	na	45	na
Family		na	16	14	13	13	13	12	13	na	na	9	na
Affiliates		na	45	36	36	38	39	37	35	na	na	37	na
Hyundai		81	80	na	60	68	66	58	61	60	61	56	54
Samsung		60	57	na	51	53	58	53	49	49	49	47	45
Daewoo		71	56	na	49	50	49	47	42	41	42	38	41
LG		30	42	na	35	38	40	39	38	40	40	40	42

Note: a 'In-group ownership' is a weighted average (where the weight is the size of capital) for shares of each business group of the family ownership plus those of affiliates.

Source: Fair Trade Commission, 1997, ‘Stock Holdings of 30 Largest Business Groups’, July 2 Press release (in Korean); and 1998, unpublished data provided to the Korea Development Institute, Seoul.

Table 9.6

Top 30 Chaebol Need to More Than Halve Debt Equity Ratios
Debt Equity Ratios^a of Top 30 Chaebol^b

	1996		1997		1998		1999
	Total	Non-financial	Total	Non-financial	Total	Non-financial	Total	Non-financial
Hyundai	376	377	437	459	579	686	483	501
Samsung	206	370	267	459	371	597	252	234
Daewoo	337	310	338	315	472	462	355	327
LG	313	323	347	373	506	543	315	279
SK	330	334	384	391	468	480	240	245
Hanjin	622	637	557	598	908	917	458	413
Ssangyong	298	289	&