[Outlook]Avoiding financial crisis

Nearly all the financial crises have certain things in common. The first common thread is the year when they occurred. There was the 1907 financial crisis in the United States, “Black Monday” in 1987, the 1997 Asian financial crisis and the subprime mortgage crisis in 2007. All happened in a year ending with the number “7.” More importantly, they have similar underlying forces leading to the crisis. Financial crises happen almost invariably when several danger factors are closely intermingled at the same time, creating a kind of perfect storm.
Recently, Korea’s financial markets and bond market became unstable.
It can be interpreted that the global credit crunch triggered by the sub-prime mortgage crisis in the United States, along with specific elements in Korea’s financial market, exerted strong impact.
When we trace the root causes of financial crises, starting from the bond market, we see a steep rise in the bond rate, meaning that the price of bonds is falling.
Whether it is bonds or cars, it is a basic principle that the price of every product is cut if supply is bigger than demand.
There are two reasons why the supply of bonds has been snowballing in the market. One is that foreign-affiliated banks that bought Korean national bonds as a way to make money at a low rate abroad have dumped national bonds because of difficulties triggered by the credit crunch.
Another reason is that domestic banks have largely increased the number of certificates of deposit (CDs) and bank bonds.
The essential role of banks is to receive and extend loans on credit. However, banks are struggling with an important problem of being short of money on credit, as funds move toward the stock market in pursuit of higher earning rates. Put simply, as the incoming money is being reduced, the outgoing money, or loans, are reduced.
However, the reduction in the scale of loans leads to the reduced size of the bank business. The bank industry is facing difficult choices because it has the notion that the total size of their assets is of utmost importance.
Unwillingly, the industry has increased the number of CD and bank bonds. The problem is that organizations can’t afford to buy bonds.
With more supply and less demand, it is inevitable that the interest rate has been soaring. Even foreigners cannot afford to buy bonds.
The credit crunch caused by the subprime crisis has prompted big buyers worldwide to withdraw funds from the emerging markets. With people relying on CD and bank bonds, the interest rate cannot help but climb steeply.
All of this means that the financial market is locked in a vicious circle of liquidity.
How then can we respond to such resolving crises? The Bank of Korea can provide emergency liquidity in the short term, but that is not the solution to eradicating the root causes.
Above all, banks should refrain from competing in the size of of their assets.
The idea that loans should not be reduced must be changed. If the amount of loans are fixed and funds are raised by constraint, it is natural to have side effects.
Even in doing so, banks cannot reduce the scale of loans indefinitely. Banks should seek new ways to make money. A CD is a short-term rate product. To invigorate investment, the danger of floating short-term rates should be hedged.
In fact, the market has no concrete means for hedging.
Alternatively, short-term rate futures can be taken into consideration, based on the Korea Interbank Offered Rate (KIOR). Bank bonds have the same case. Accompanying credit risk should be hedged in order to expand the scope of investments.
From the banks’ perspective, liquidity may be wielded based on loan assets in possession. And liquidity securities may be issued as a way to assemble bank bonds.
If the credit crunch is being aggravated, the liquidification of assets can play a pivotal role in the financial market.
As shown in the case of subprime crisis, the crisis of liquidity has been often triggered by overseas factors. As for liquidity, Korea is in a very special position.
Among emerging markets, Korea is the market equipped with the highest liquidity.
When global investors try to get out of emerging markets, they usually withdraw their money from the Korean market, where encashment can be easily done.
What should we do to tackle the problems? Korea boasts the world’s 13th-largest economy, and plays a leading role in world-class industries such as semiconductor and shipbuilding.
It is also ranked as the world’s 15th-biggest stock market in terms of its overall market price.
We cannot understand why Korea should be grouped as one of the emerging markets despite its huge market size.
Korea should do its utmost to get out of the emerging market group. It is the best way to avoid the liquidity crisis.
The president should be at the forefront of managing Korea’s financial crisis. Migration into the developed markets from the emerging markets is a national strategic task that the president-elect and the new government should strive for.

*The writer is a vice president of the Korea Securities Research Institute. Translation by the JoongAng Daily staff.

by Kim Hyoung-tae