Financial industry fails to reach its potential

Although Korea became the world’s 14th-largest economy due to rapid growth of the IT and traditional manufacturing industries, there is a widespread view that the country’s financial industry remains relatively undeveloped.

In its annual report on the competitiveness of 144 countries in various areas, the World Economic Forum (WEF) ranked Korea 80th this year in terms of financial market maturity compared to its potential - far behind some developing countries like Ghana, Cambodia and Colombia.

The WEF measures financial industry maturity by such metrics as availability of venture capital, capital finance through the stock market, cost of financial services, accessibility to loans and fiscal soundness of banks.

Korea ranked 120th in access to loans and 122nd in fiscal soundness of banks. For a country that ranks 26th in terms of overall national competitiveness, Korea’s performance in the financial market maturity category is shameful.

Worse, the Korean financial industry has been making headlines lately for all the wrong reasons: shameful accidents and scandals - ranging from mismanagement of customers’ personal information and illegal sales of corporate bonds - to scams by bank executives and employees and internal power struggles by top management.

The latest KB Financial Group scandal, in which a boardroom feud between the group chairman and bank CEO led to the dismissals of both, is considered the epitome of financial-sector immaturity and revealed a set of growth-hindering problems such as excessive regulation and government interference.

Excessive and unnecessary regulations are being blamed as the real culprit behind various problems in the industry.

A survey by the Federation of Korean Industries showed that more than 60 percent of foreign financial institutions operating in the country cited excessive regulation as a major obstacle to growth.

“The Korean financial market is a well-regulated market,” said a CEO of a major foreign financial company here, who declined to be named. “They physically conduct investigations too often, which can be seen as wasting time and money on both sides.”

“Watchdog officials stay at our office at least once every two years for checks,” said a spokesperson for a foreign asset management company. “But they raid unexpectedly if anything happens, which makes financial institutions feel that the government is too demanding.”

The spokesperson said it is almost impossible for any financial institutions to meet standards and comply with every detail of every rule, especially regarding financial products, because in today’s financial world, there are countless different and novel financial products being developed in pursuit of higher profits.

The country’s two financial authorities - the Financial Services Commission (FSC), in charge of devising financial policies and regulations, and the Financial Supervisory Service (FSS), which monitors the industry and enforces regulations - have been criticized for issuing too many regulations in an inefficient manner, which leads to ineffective supervision.

The authorities have excessively detailed rules and regulations that affect new financial products, operations and management.

“Too much regulation is the cause of all problems,” said Lee Min-hwa, a professor at the Korea Advanced Institute of Science. “Ranging from management of computer systems to security guidelines, the authorities are supervising the financial institutions too much.

“In the Korean financial sector, it is hard to find autonomy and competition. Instead, there is control and protection.”

Others say the financial industry should be protected by the government because it serves the public interest.

“It is right to call financial entities ‘institutions’ instead of ‘companies,’” said a director general at the FSC. “It’s because they are supposed to serve the public interest. In this sense, it is also right to say it is a relatively closed sector compared to the manufacturing industry.”

After the KB Financial Group scandal, the FSS announced last month an overhaul of its watchdog role as part of efforts to take responsibility for failing to properly handle the internal feud.

The organization oversees financial institutions such as commercial banks, savings banks and insurance companies. The authority can inspect questionable transactions or mistakes made by the institutions and impose penalties.

According to the overhaul plan, the watchdog will reduce its customary investigations by more than 50 percent in order to minimize interfering with management. The FSS has been conducting 45 investigations per year and checks on each of the country’s 3,600 financial institutions once every two to three years. Starting immediately, the FSS will limit its investigations to 20 per year and focus on unstable companies.

“Reducing the number of investigations is not the point,” said Kim Dong-hwan, a senior research fellow at the Korea Institute of Finance (KIF). “The key is whether or not imposed penalties are effective.”

Kim pointed out that rather than focusing on the prevention of accidents and wrongdoing, authorities seem more interested in punishing somebody in the industry.

Last year, the FSS punished about 4,200 executives or employees of local financial institutions, up about 25 percent from the previous year.

In comparison, the U.S. Federal Deposit Insurance Corporation conducted about 1,500 inspections of financial institutions from 2011-13, but imposed penalties on only 307 individuals, according to a KIF report. Instead of punishing individuals, U.S. authorities levy heavy fines on institutions.

While the largest fine on institutions by Korean authorities is about 500 million won ($472,000), the report said, U.S. authorities have no limit on the amount they can levy.

To prevent accidents and scandals in the financial industry, Oh Jung-gun, chairman of the Asia Finance Society and a professor at Konkuk University, calls for a massive overhaul of the financial supervisory system.

“The supervision function of the authorities should be separated from the policy-making function,” said Oh. “Supervisory measures should be made to protect the industry rather than control it, while financial policies should be created for growth of the industry.”

The Korean industry’s bank-centered structure also is cited as a problem that causes imbalance among sectors and uneven growth.

“The Financial Services Commission should be called the ‘Bank Services Commission,’” said Bahk Byong-won, chairman of the Korea Federation of Banks. “The authorities are not much interested in other sectors of the financial industry.”

Bahk argues that creation of the financial group system was a mistake, considering the nature of the Korean financial industry.

“Financial groups were made to encourage even growth of the entire industry. Instead, they cause power struggles between the group and bank management,” said Bahk. “The bank business long ago reached its saturation point. For real growth in the financial sector, the government should push for growth of non-bank businesses, such as securities and insurance.”

Another problem is that banks are at the center of the whole industry, but their profitability keeps dwindling.

Aggregate net profits of the banking sector were 8.77 trillion won in 2004, but that figure plunged to 3.88 trillion won last year, which means that while the country’s economy continued growing, the banking sector shrank.

The return on assets (ROA), an indicator of banks’ profitability, was 0.38 percent last year, lower than that of Singapore, China, Hong Kong, Malaysia and Indonesia, according to a survey by The Banker, a U.K. publication for global financial institutions.

Due to falling profitability, fewer people are landing jobs in the financial sector. As of July, the number of newly employed people in the financial sector was about 49,000 less that it was in 2013, according to a Statistics Korea report.

BY SONG SU-HYUN [ssh@joongang.co.kr]