[Viewpoint] Building up the banking industry

The curse for Korean banks is that none of them can remain No. 1 for more than a decade.

Since bank privatization in 1983, Cho Hung Bank, Commercial Bank, Jeil Bank, Hanil Bank and Seoul Bank have been more or less on the same level. In the early 1990s, Cho Hung Bank and Commercial Bank led the way, and Jeil became the top bank later. Commercial Bank took the top spot again after the fall of Jeil Bank. Banks became bigger or smaller repeatedly in accordance with their fluctuating fortunes and financial policies.

No one among the aforementioned banks survived the whirlwind of liquidation and mergers following the 1997 financial crisis. Today, Kookmin Bank is a leader with sound consumer banking products.

As such, fluctuations in the banking sector are mainly due to a lack of competitiveness, because the government emphasizes the bank’s role of supporting development of other industries, rather than seeing finance as an entire industry. Persistent government intervention in loaning as well as bank personnel policies has hampered self-disciplined management. As banks have paid little attention to loan inspections or risk management techniques, deficits have continued to mount. As shown by the example of collateralized debt obligations investments or the sale of the currency option called “knock-in knock-out,” or KIKO, the risk management level of the bank falls short of market expectations. Is it mean to say that they sold such products in ignorance? While they failed to manage the loan-deposit ratio or liquidity ratio properly, they have faced difficulties during the financial meltdown.

A major culprit behind failed risk management is repeated external competition, rather than actual substance. Bank presidents often conclude an agreement with the general manager on increasing assets above a certain level. Then the manager is forced to invest in high-risk derivatives. If a bank reduces its external form, its employees will be anxious about whether to be able to secure their posts. Therefore, executives, including the bank president, cannot help but push short-term yields higher, leading to distortions in the reward systems. No matter how plausible the results, however, serious structural problems continue to accumulate.

In addition, Korean banks are poor at coping with emerging risks, with their limited knowledge and experience. Despite their pride in skillful risk management, they have been sorely shaken up by the fallout from complex derivatives.

In addition, risk management has been more concentrated on the financial sector, with no consideration of small and medium-sized businesses, which do not go through an external audit and thus may manipulate their firms’ financial statements. No considerations are paid to qualitative factors, such as future potentials, and the CEO’s executive capability in appraising firms, due to the need to clarify where the responsibility lies. In addition, banks have promoted personnel within the business and planning departments to responsible posts. Many highly qualified personnel hesitate to work in the risk management department, including the inspection department, which has always experienced volatility.

Banks that suffered during the recent financial crisis due to a lack of dollar deposits are poised to puff up to severalfold their original size. Following the prospective sale of Woori Finance Holdings and the Korea Exchange Bank, the scheduled privatization of the Korea Development Bank, the bank sector has adopted a strategy to occupy dominant positions through the merger and acquisition process.

In particular, they are insisting on the need to increase assets to at least 400 trillion won ($342.55 billion) to compete with giant banks in China and Japan with assets exceeding 1,000 trillion won. Kookmin Bank has become the largest bank by increasing its total assets to 282 trillion won. As many objections are raised over the current investment banking model, economies of scale are needed for commercial banks that provide deposit and loan products. However, it is doubtful whether banks poised to participate in mergers and acquisitions are equipped with the necessary capability. The point is that they should strive to raise their global competitiveness. Some people point out that “mergers and acquisitions should diversify the scale of the risk factors in the enlarged portfolio. However, puffing up earnings entails bigger risks in Korea.”

If a bank fails to manage risks while bent on increasing in size, serious damage will be inflicted on the people of this country. This is the reason banks should not be run in an aggressive manner although it is good to proactively manage banks. Woori Bank was twice forced to take 1.3 trillion won from the watchdog’s capital fund, in 1998 and again in 2000.

In addition, after the worldwide financial meltdown, 1.7 trillion won was used to cover deepening deficits at the bank at the end of March.

The overall gains from a bank will return to investors or employees, while the huge deficit caused by the failure at risk management is likely to be inflicted on people. Banks will enjoy high net profits by raising fees or using the margin between deposit and loan rate to make up for their losses. However, these risks should be borne by the public and customers. Securities firms will be forced to bear all of the costs of their risky choices, whereas banks should be held responsible for risk management.

Recently, many people have insisted on the need to set the national agenda to develop the financial industry. To this end, a suggestion was presented to create a high-level joint government-private sector committee, in an effort to facilitate the emergence of large global financial conglomerates and help the financial sector’s capacity to generate competitiveness. Unless banks undergo reforms, there is a long way to go.

We therefore urge the banking sector to “show yourself strong before you compete to puff up in size.”

*The writer is the senior economic news editor of the JoongAng Ilbo.
Translation by the JoongAng Daily staff.

by Park Eui-joon