Financial and Corporate Restructuring In Korea








- Luncheon Address at

an AmCham & EU Joint Membership Meeting -

on Tuesday, October 27th, 1998










Lee Hun-Jai


Financial Supervisory Commission



President Werner D. Graessle of the EU Chamber of Commerce, President Jeffrey Jones of AmCham, Distinguished Guests, and Ladies and Gentlemen:


I am glad to have this unique opportunity to talk about the progress in financial and corporate restructuring and future tasks.


It is less than a year since the crisis broke out in Korea, but the situation in this country is already quite different, although difficulties are not yet over. Recently the international community including IMF and the World Bank highly praised the impressive progress Korea has achieved and foreign investors are coming back to Korea.


After the outbreak of the crisis last December, the Government had to make crucial decisions on how to react, what to do and what not to do. Let me mention four points. First, the Government will not bail out non-viable financial institutions. Fiscal support will be provided to viable institutions only as a way to expedite their rehabilitation, but conditional upon the institutions' comprehensive self-rescue efforts and accountable loss-sharing to prevent moral hazard.


Second, institutional settings including prudential regulation and accounting rules have to be strengthened by fully incorporating global standards. Whatever the ultimate causes are, there is no denying that the magnitude of current crisis was amplified by capacity-driven policy, loose market discipline and lack of transparency. Also, before the crisis, the scope of regulations for financial institutions was not adequate and the degree of its implementation did not comply with international standards. Third, corporate restructuring has to be pursued in tandem with financial restructuring. The NPL burden at financial institutions will not be lessened and sound management cannot be secured, unless the problem of corporate failures is solved. Therefore, non-viable corporates that are not able to make profits even under normal financial conditions are to be exited. On the other hand, viable corporates will receive various support measures such as workout based upon accountable loss sharing.


Fourth, in order to regain confidence from abroad we will honor the agreements made with IMF and the World Bank, an integral part of Korea's progress to date. The capital market, including foreign direct investment, has been dramatically liberalized. Corporate M&A and real estate acquisitions are also widely open to foreigners.


Process of financial restructuring


Let me first give you an overview of what we have accomplished in financial restructuring. As you may well know, the Government decided to shut down five severely undercapitalized banks last June. On the other hand, 7 troubled banks which received conditional approvals, are now taking steps to execute corrective actions. Out of the 13 remaining banks, some banks are seeking mergers with other banks. If any of these banks are found to be deteriorating, they will be subject to corrective actions. FSC has already implemented "management improvement recommendations" to three banks in this category.


Successful privatization of Seoul Bank and Korea First Bank is crucial because it will bring back market confidence as well as fresh capital to the banking sector. The government is fully aware of potential buyers' concern on downside risks. Therefore, feasible asset protection schemes will be provided to make these banks more attractive. Although restricting the eligibility for potential bidders makes the sale process more difficult, it is the Government's firm position that the banks cannot be sold to domestic chaebols.


It is not only the banking sector that has experienced drastic changes. We have also undertaken substantial measures in the non-bank financial sector as well. To date, 16 merchant banks, 2 investment trust companies, 4 life insurance companies, and 6 securities companies have been either closed or suspended.


Government support


In an effort to support rehabilitation efforts undertaken by financial institutions, the Government continues to provide fiscal resources allocated from an outlay of 64 trillion won specifically devoted to facilitating financial restructuring.


Before last May, 14 trillion won of fiscal support was provided to the financial sector. At the end of September, 21 trillion won of fiscal support was provided. Of this amount, 9.1 trillion won was used by KAMCO to purchase 23 trillion won of NPLs and 11.9 trillion won by KDIC for recapitalization and for compensation of liabilities in excess of transferred assets for closed institutions. By the first half of 1999, the remaining 29 trillion won is scheduled to be used to facilitate further restructuring. We expect the funds to support more merger activities as well as other self-rehabilitation efforts.


The Government support has been exercised only under the strict condition that banks pledge drastic loss-sharing and self-restructuring efforts. Their implementation will be, of course, closely monitored by the FSC. Through such restructuring of banks, we have seen more than 20% of employees reduction and more than 700 branches shut-down.


Future NPL size and resources for solving related problems


I am aware that there are still many concerns on the possible deterioration of bank asset quality as the corporate sector remains to be under financial distress. However, to my understanding, the market perception tends to exaggerate the magnitude of the problem. In fact, there is little probability that the NPLs will increase a lot since the interest rate came down to the lowest level and Korean economy caught a momentum to rebound by its restructuring efforts combined with favorable world economic situation. Although NPLs are not likely to exceed originally forecasted 120 trillion won even at its peak, any further deterioration of bank loans will be counteracted, if necessary.


There are other alternatives to extending fiscal support. First, further provisioning. In the first half of this year, banks have already set aside 7.8 trillion won of their earnings. In addition, in the event that KAMCO successfully sells its portfolio or KDIC retrieves its capital from rehabilitated banks, the proceeds would be used for additional NPL purchases or recapitalization needs. Lastly, but not the least, private capital can be induced into banks as their balance sheets are cleaned up.


Future task of bank reform


The terms of reference (TOR) given to merged banks as conditions for government support are designed to improve several management measures, which will bring productivity and earning potential of the merged bank up to that of advanced countries'. The TOR contains near-term profit improvement, bad asset disposition, M&A integration and post-merger management, recapitalization plan, improvement of corporate governance, risk management, information technology, organizational structure, and financial projection in which ROA needs to exceed 1% and ROE to exceed 15%.


Meanwhile, as a way to ensure soundness and competitiveness of banks, FSC distributed strategic templates to all banks. This template can be used as a software, providing banks an opportunity to internally assess the real situation up front and help them develop comprehensive business strategies, incorporating international best practice.


Enhancing prudential regulation and supervision


Now, I would like to explain our efforts regarding the development of prudential regulation and supervision. First, loan classification and provisioning requirements have been strengthened. For example, previously, loans past due over 6 months were classified as substandard. However, now, loans past due over 3 months are classified as substandard. Moreover, effective as of next year, we will introduce a forward looking criteria as the official loan classification standard. In addition, we upgraded financial institutions' accounting, auditing, and reporting systems to international standards. We will also issue prompt corrective action notices from discretionary to mandatory. Previously regulators 'can or may' take regulatory actions to financial institutions when their BIS ratios fall below certain requirements. However, from now on, regulators 'should or must' execute the action as a mechanical procedure without exception. This implies that the financial restructuring process will continue automatically based on clear and transparent principle.


Corporate restructuring


Ladies and Gentleman, let me now turn to the topic of corporate restructuring which, I think, is your utmost concern. Earlier this year an agreement on 5 underlying tasks for corporate restructuring had been reached between at that time President-elect Kim Dae-Jung and Chaebol owners. Afterwards, the top 5 chaebols were acknowledged to have the ability and capacity to pursue restructuring on their own efforts, while for '6 to 64 chaebols', the workout is applied as a major tool. In this regard foreign advisory groups were hired, utilizing IBRD technical assistance loan (TAL).


Currently 15 out of top 64 Chaebols and additional 26 corporations are under workout process. Among these, 5 Chaebols have already come up with reasonable workout schemes. Through these process, financial institutions are learning a lot about corporate workout and most importantly, they are beginning to think in a commercial perspective. They will speed up the process as their experience accumulates. I am very proud that Korean banks started to lead corporate restructuring by fulfilling their role as creditors. I'd like to emphasize that this development itself is real restructuring, enabling Korea to maintain a competitive edge in international market.


I also feel very relieved by the significant developments made very recently in the top 5 chaebol restructuring. The government and top 5 chaebol owners have reached an agreement on eliminating cross guarantees between different sub-groups within each chaebol by the end of this year. Then the same policy framework will be applied for the resolution of companies within each sub-group. Following these process, the capital structure of corporates with core competence will be improved through workout.


Eliminating cross guarantees between sub-groups will place them in a better position for MBOs or spin-offs. Related laws including the "Fair Trade Act" will be flexibly applied to facilitate such restructuring process. For example, the parent company will be able to provide financial assistance or capital injection to those affiliates that are spinned off.


The Government and top 5 chaebol owners also agreed that concrete management improvement plans for asset swaps and merging in 7 industries, generally known as the "big deals" should be submitted by the end of October. And by November 15th, a special committee composed of creditor institutions will review them for its feasibility. When it comes to the implementation stage, the chaebol restructuring plan will be executed in a transparent manner to secure a successful workout.


Small and medium sized enterprises


SMEs, which are financially vulnerable, are suffering too much from the credit crunch. As the economy starts its rebound, many SMEs can move into more value-added businesses. Therefore, the Government will provide intensive care for financially distressed, but solvent SMEs to help them turn-around. Some of them are already under workout processes and other various support measures are also in place. Especially, SMEs in grey zone, evaluated as viable by the creditor banks, will receive financial support and it will work as a clear message on their viability to the market.


Future task in corporate restructuring


Let me now turn to the future policy directions on corporate restructuring. First of all, FSC will not hesitate to go into second round of corporate workouts for chaebols with the help of foreign Advisory Groups now assisting major creditor banks. Secondly, top 5 chaebol restructuring will be driven as scheduled and government will provide guidelines on specific issues like cutting cross guarantees and reducing debt-equity ratios. I think, so far, we have made tremendous headways in setting up a rigorous framework for chaebol restructuring and it's time for us to implement it in a serious manner. Finally, as in the financial sector, non-viable corporates will be subject to exit the market on a continuing basis.


Closing Remarks


Let me conclude with the future prospects of our economy. We have just passed through the first round of restructuring by mopping up and chiselling away bulky problems. Nevertheless, there are still lots of work to do. Among other things, it remains our utmost task to transform the management to secure soundness and competitiveness.


Thanks to the successful stabilization of the exchange market, we have already witnessed lowered interest rates, which will reduce financial costs and increase domestic demand. The macroeconomic policy coordination at the global level towards sustainable world growth is also highly welcomed. The improved macroeconomic and external situation along with ongoing restructuring process will help mitigate the severe credit crunch and economic contraction. We expect that the economy will hit bottom by the end of this year and will return to positive growth next year.


The reform process that has been pursued is irreversible. The international standards of market principles have already been installed in all sectors of our economy. You can be assured that Korea will

continue to differentiate itself from other crisis-hit countries through comprehensive reform.


By turning the crisis into an opportunity for another take-off, Korea will be reborn as a reliable counterpart in the international community once again. Your trust and participation will be increasingly important for us to accomplish this task, and I am sure that your dedications will be rewarded when we share our achievement.