[VIEWPOINT]How to break banks' bad habit

Many financial analysts have expressed concern over the sharp rise in the amount of consumer loans. Government reports that consumer debt had reached 341 trillion won ($263 billion) at the end of last year, a 28 percent increase over 2000. Consumer loans accounted for 37 percent of all bank loans. The government tied the increased consumption to low interest rates, an increase in the number of self-employed, declining corporate demand for capital due to stagnating investment, widespread use of credit cards to make purchases and installment payments. But this analysis is flawed, since it does not mention why the financial institutes increased the amount of loans to households.

Banks have shunned corporate loans, which are somewhat riskier, focusing on loans backed by real estate.

We should try to estimate how loans backed by real estate will affect the Korean economy. Government officials and analysts say the collapse of the Japanese economy stemmed from the drop in the prices of real estate that the banks held as collateral. Japanese banks became insolvent with the sudden rise in unreliable loans. The trouble might not end there. There may be pressure to create inflation to appreciate the deteriorating value of the bank loans. An increase in consumer debt may lead to stagnated consumption, spawning an economic slump. If banks prefer to secure collateral rather than evaluate the liabilities of loan projects, it is difficult to prevent corporate bankruptcies and the distribution of available resources will be distorted.

There are other problems. Around 30 years ago when Korea was undergoing rapid economic development, corporations and banks encountered little difficulty in discovering profitable ventures. But as Korea's economic structure advanced and the business environment became unstable and volatile, corporations have encountered increasing difficulty pinpointing in which sectors to invest. The uncertainty caused many firms to invest by chance or go through the ordeal of trial and error in determining the best projects. If financial institutions are unwilling to take risks, preferring to secure collateral, corporations will not get the opportunity to try their projects, which would result in stagnating investment and economic growth.

Banks should always consider making risky investments. They should not take the risks; they should deal with the risks. But Korean banks are not used to dealing with risks; they have prospered under a management system that shifted responsibility for bad loans to the government.

The banks prefer providing consumer loans and purchasing state bonds; they are reluctant to lend to companies. Many small and medium-sized firms suffer from a dearth of capital although interest rates are low. They do not have enough collateral to back a loan from a bank. The private sector has reported a decline in investment for the last several years, and we cannot deny that the decline may be a result of the passive attitude of financial institutions.

Western banks have many ways to manage risks. First, they can hedge risky loans by introducing provisions of assurance to cover bad debt and hiking interest rates on defaulted loans.

Second, banks should develop techniques to evaluate the creditworthiness of a corporation and strengthen criteria used to determine the economic feasibility of loan projects. Third, they can issue shares on the corporate loans they have provided and circulate them in the security market. Fourth, procedures for dealing with bankrupt firms should be simple and swift, and the insolvent firms should be sold off quickly. Measures to strengthen the nation's financial market were introduced after Korea was hit hard by the financial crisis in 1997, but the results of such efforts have not been seen.

But relying on the marketplace is not the only way to solve the problems plaguing Korean banks. The government and the Bank of Korea should urge banks to end their heavy dependence on real estate for collateral. First, the Bank of Korea should differentiate the interest rate it offers to other Korean banks, according to the percentage of healthy loans it provided without collateral. Second, a new evaluation system that favors banks with the highest percentage of sound loans should be put in place. The scoring should weigh toward banks offering collateral-free loans. Third, to induce Korean banks to learn management techniques of their Western counterparts, whose dependency on real estate is low, the government should set a limit on the amount of collateralized loans.

Korea will never achieve economic restructuring if the government does not wean banks from their heavy dependence on real estate in providing loans.

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The writer is an economist and former prime minister.

by Nam Duck-woo