Problems with 3 Financial ReformsDestitute Banks Should Be Allowed to Go Bankrupt
I wish to take issue with three of the reforms the government is pursuing in its attempts to solve the problems endemic to the South Korean financial sector.
The first has to do with the partial deposit insurance system. After the appointment of a new finance and economy minister, the ministry conducted surveys for 70 days and finally decided on a scheme that would guarantee individual deposits at any single financial institution of up to 50 million won ($44,000).
The ministry originally set the ceiling at 20 million won, but reportedly settled for 50 million, deciding the earlier ceiling was too low, 30 million insufficient and 70 million too high, in a stark example of using the rule of thumb in important policy decisions.
It did not give specific examples of the benefits that would accrue from raising the ceiling from 20 million to 50 million won, however.
The government maintains that deposits would move from weak financial institutions to healthy ones under the new system and, in the process, nonviable ones would be liquidated according to market principles. On the surface, the argument sounds plausible.
It is difficult for depositors, however, to distinguish between the healthy and the weak when information on their health is hard to come by.
Speaking frankly, there might be less-ailing banks in Korea, but no really robust ones. This makes depositors highly sensitive to rumors, which in turn further destabilizes the financial market.
A few months ago in another article in the JoongAng Ilbo, I called on the government to guarantee only up to 20 million won as it had promised when it received emergency bailout funds from the International Monetary Fund.
I also said it should guarantee 90 or 95 percent of the deposits in excess of 20 million won, to make both the deposit insurance apparatus and depositors jointly responsible. This method must have seemed too complicated for the officials.
Some people ask whether my concept is not for the benefit of the rich, to guarantee their large deposits. Under a system that protects only 20 million or 50 million won, however, many of the hundreds of thousands of individuals with over one billion won in deposits would take advantage of the eased restrictions on foreign currency transactions to move their deposits to foreign banks. We have to consider the possibility of billions of dollars taking flight from the nation.
A deposit insurance system is literally just an insurance system. Winnowing out the weak from the healthy is its secondary function.
I am not sure if the government has the courage to allow nonviable banks to die a natural death either. In light of its plan to establish financial holding companies to merge with the banks that are unable to survive independently, the government does not seem willing to pull the life support system from sickly banks.
Liquidation of a company is the natural course if it fails to generate operational profits. If the government protects ailing banks under the umbrella of financial holding companies, it would not be easy to hold the people who had caused the insolvency responsible. While this might be good news for the culprits, it casts a pall over the future of the nation''''s banking industry.
Ailing banks would not see their management conditions improve just because they come under holding companies. Merging the infirm with the healthy does not create a strong company. The insolvent banks would only end up being a huge burden that continues to swallow public funds.
It would be wiser to funnel the funds to healthy banks, or to the less-ailing ones, to nurse them back to full heath. Or they could be used to minimize side effects caused by the bankruptcies of inoperable banks.
On another front, the government''''s plan to raise the ceiling of bank ownership from the previous 4 percent to 10 percent is grievously disappointing.
This issue had appeared to be settled when the public opposed raising the ceiling, since it would allow chaebols, the nation''''s giant family-owned corporations, to make inroads into the banking sector. But the government seems set on offering the chaebols this as a carrot, perhaps to allay its sense of guilt for trying to reform them in what can only be described as a pallid drive.
I want to ask the government whether it believes the bankruptcies of Hanbo and Daewoo were caused by the absence of owners, and whether Hyundai Engineering and Construction is in difficulties because it did not have an owner, i.e. a large shareholder.
I also want to ask whether it has forgotten the cause of the financial crisis that beset the nation at the end of 1997.
The crisis took place because financial institutions under chaebol ownership supplied funds to their parent companies and subsidiaries without restraint, resulting in excessive and overlapping investments.
In a nutshell, the partial deposit insurance scheme has to be based on the framework of a joint responsibility system, and destitute banks should be allowed to go bankrupt according to market discipline. And the government certainly should not raise the bank ownership ceiling.
The writer is a professor of economics at Seoul National University.
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