Striking the right balance

Korea has the 13th-largest economy in the world and is eighth in terms of the size of its trade. In the Global Competitiveness Report of the World Economic Forum, Korea ranks 26th out of 144 countries. However, the country scores poorly on the financial market scale. It is 80th, far behind the Philippines at 49th and China at 54th.

The government has been continuously developing the financial industry. It has enforced stringent restructuring and toughened regulations to match up to international standards since the 1997 financial crisis. Over the last two years alone, there have been numerous measures to improve the financial regulation system, the competitiveness of industry and to promote innovative financial techniques. And yet there is still a lot to be done in the area of ownership and governance structure in financial institutions, the relationship between industrial and financial capital, management transparency, risk control capabilities, consumer protection and the supervisory system. Preparation must be made against surging household debt, the shadow finance market and changes in the world market.

The global financial crisis in 2008 underscored that finance cannot be run by the market alone. The United States scrapped the Glass-Steagall Act in 1999 to lift the ban on affiliations between banks and securities firms and other regulations for greater liberty in the financial market. Monetary institutions, licensed with unrestricted freedom from their supervisors and state regulators, sought bigger risk-taking in competition for higher yields, developing various complications and dubious derivatives to extend loans and debt. The financial market turned into an expansive high-stakes gambling table. Alan Greenspan, who headed the Federal Reserve for 18 years from 1987, was a defender of the free market with the basic theory that policy makers should not keep the interest rates low for too long. The financial industry finally faced a cascade of household debtors who could not meet their mortgage obligations. The U.S. housing bubble bursting triggered a meltdown in mighty financial lenders, starting with Lehman Brothers in September 2008, taking a toll on the world’s economy.

The earlier Asian currency crisis in 1997 was brought about by the opposite - over-regulation and excessive state interference. It can be effective in the economy’s early developmental stage for the government to take control and channel capital into a selective industrial area, but such meddling can end up distorting and undermining efficiency in the market. Even with good intentions, the government cannot be fully aware of the complicated market factors, and sentiment and policies may not produce the desired outcome. Heavy-handedness had been rampant in the financial sector in the late 1990s. Excessive meddling and customary reckless lending practices generated bad loans and exacted the liquidity crisis in 1997.

Too much and too little liberty in the market can all hamper the financial sector and its development. The government must be prudent in its interference with its role kept to ensure stability in the financial system and progress in industry. Recent state and bank collaborations to help household lenders restructure their existing loans to lower and fixed rates and longer-term maturity received an enormous response. The annual batch of 20 trillion won ($18 billion) was exhausted in just four days. The cap was expanded by 14 trillion won. Over 330,000 people were able to restructure their loan payment plans to monthly installments at lower fixed rates. Still, the loan program was criticized for excluding lenders of the nonbanking sector - the ones who really need relief from high interest burdens - and for helping little to lower the total household debt stock. The measures are makeshift. Without improvements in business and income, households will continue to have trouble paying off their loans and the household debt problem could worsen.

A policy loan to relieve household debt should, however, contribute to containing the problem to some extent. But this has taken place without sufficient coordination and communication with the financial sector. Banks’ revenues will be hurt by the conversion of fixed and lowered rates into loans. Banks must sell debt-backed securities to the Korea Housing Finance Corp. and use the funds to buy mortgage-backed securities and keep them for a year. They could also incur losses when interest rates move higher. Authorities have assured that they will make up for the losses but that they should have discussed the means of sales, scale, timing and management of the assets sufficiently before they launched the loan program.

It is wrong that financial institutions customarily take orders from authorities. The government interferes too often and excessively. Financial institutions are often called upon to cooperate with government policies unrelated to their business. Ownership and governance structure in financial institutions is too weak to fend off and resist government command. Revolving-door practices continue. An organization that moves upon outside orders cannot be competitive. The new chairman of the Financial Services Commission said he will work towards rationalizing regulations and promoting a market structure where financial players will be more liberal in their activities and take responsibility for their actions. The ownership and governance structure and old practices must be fixed first. The financial industry must be able to grow and compete alone.

Translation by the Korea JoongAng Daily staff

JoongAng Ilbo, April 10, Page 35

*The author is an economics professor at Korea University.

by Lee Jong-hwa