What’s a BIS rate?Earlier this year, the nation was in a hubbub over the alleged fabrication of the Bank for International Settlement, or BIS, rate for Korea Exchange Bank when it was sold to U.S. investment fund Lone Star three years ago.
What is a BIS rate, and how can it cause such a national commotion?
Let’s go back to 2003, when Korea Exchange Bank was up for sale. At the time, the bank was in a critical financial situation. It had given a huge loan to Hynix Semiconductor, but the computer chipmaker’s business was far from profitable.
Therefore, the bank risked losing all the money it had loaned.
To make the situation even worse, the bank’s credit card section was facing a deficit, since credit card customers were not paying their bills.
The only way to make the bank sound again was to either attract investors or pour in public funds. At the time, the National Assembly was opposed to further spending of public funds on insolvent companies. Therefore, the only way left for Korea Exchange Bank to survive was for it to be sold to an independent investor.
The standard used to make the final decision to sell the bank was the BIS rate.
A bank where a large number of customers entrust their money should be strong enough to return those deposits at any given time. This is the standard used to judge whether a bank is sound.
The Bank of International Settlement devised a standard that could be applied to every bank in the world. This is the BIS rate and acts as a measurement in evaluating a bank’s soundness.
So, how is the BIS ratio calculated? A bank’s assets are calculated by subtracting the company’s debts from its entire fortune.
In addition, a risk-weighted asset is one in which the bank has made loans to companies that it may not be able to recover. The BIS rate divides the bank’s assets and the risk-adjusted assets. In other words, the BIS rate is an index that shows whether a bank has enough financial backup in case of an emergency.
A bank is conisdered sound if its BIS rate is over 8 percent. Until the Asian financial crisis in the late 1990s, the concept of a BIS rate was new to Korea.
The Korean government agreed with the International Monetary Fund to eliminate banks whose BIS rates failed to reach 8 percent, in exchange for receiving a $55 billion loan. This agreement struck fears into Korean banks. Small regional banks whose BIS rate fell below the standard disappeared from the market.
Korea Exchange Bank was also facing extinction. In the summer of 2003, the government and the management of the bank predicted that if the bank did not attract more investments by the end of 2003, its BIS rate would fall to 6.16 percent. The bank was in a situation where a large group of customers would close their accounts once the bank’s BIS rate fell to the 6 percent range.
Lone Star was the only investor that volunteered to invest in the bank.
Lone Star is not exactly a financial institution. As an investment fund, it is by law not qualified to take over a bank. The government, however, fearing financial chaos due to Korea Exchange Bank’s low BIS rate, permitted Lone Star to buy the bank.
The bank’s business, which saw a deficit of 210 billion won ($222 million) in 2003, then started to improve and last year became profitable, when its net income tripled to 1.9 trillion won. Lone Star decided it was time to sell the now-profitable bank and earn 4.5 trillion won by selling it to Kookmin Bank.
The government was accused of selling the bank at a lower value to Lone Star and only contributed the profit enlargement of the U.S. investor. Suspicions were raised that the government had fabricated the 6.16 percent BIS rate to make it easier for Lone Star to take over the Korea Exchange Bank.
How does a BIS rate go up and down? If the assets increase and the risk-weighted assets decrease, the BIS rate will go up. If it is the other way around, the rate will go down.
The rate naturally goes up when the bank makes a profit or if investors increase their investment. In 2003, the bank was accused of enlarging the losses from its credit card sector and loans to Hynix from 1.3 trillion won to 1.7 trillion won. The larger loss allegedly lowered the BIS rate. The government says this is absurd, but prosecutors are investing the issue and the results of their investigation is as yet unknown.
Private equity funds: Betting on if you can turn a company around
As much as the BIS rate has been in the public interest, so has the the U.S. investment fund Loan Star, the private equity fund that took over the Korea Exchange Bank in 2003. Carl Icahn, the invester who bought a large chunk of KT&G recently, also heads a private equity fund. But what exactly is a private equity fund?
A private equity fund is very different from other funds managed by banks or brokerage firms that are publicly listed. It is an investment that solicits only professional investors.
So why would a private equity fund keep their investors exclusive? Private equity funds invest not in ordinary company stocks such as those for Samsung Electronics or Hyundai Motor. Rather, they invest in companies whose business has gone bad and which need help recovering.
Private equity funds make their profits by normalizing the companies and selling them.
Since a huge sum of money is needed to buy companies, a private equity fund looks not for ordinary investors, but for those with massive amounts of money to invest. This is why institutional investors such as pension and insurance funds are investors in private equity funds.
In the United States, universities such as Harvard and Yale invest in private equity funds.
The U.S. government pension fund and renowned universities such as Stanford and MIT have invested in Lone Star.
Such a private equity fund can be the center of public interest, since a powerful private equity fund can decide the fate of a company.
Private equity funds seek out any market that will provide a profit, and the Korean market, which had many insolvent companies after the financial crisis, was an excellent target.
by Yoon Chang-hee, Kim Joon-sool