Imprudent deregulationUnlike exports and imports of goods, what trades in the finance market is credit, or a promise. Instead of transactions made on the spot with a swap of goods and cash, what is exchanged in the finance market is an arrangement for repayment or a return of the resource at a later date. The finance industry pools short-term capital and rearranges it into longer-term loans to earn profit. In case of misfortunes - such as defaults or bank runs - financial troubles can blow up into economic crises. That is why the finance sector demands strict regulation and supervision.
Financial regulations change according to the times. They toughened in the wake of the Great Depression in 1929 and eased during the 1970s. The lid was put tightly back on the industry after the Wall Street meltdown in 2008. The British and U.S. governments drew up new laws to toughen oversight and restrictions over the operations and business activities of financial companies and impose strict guidelines on debt ratios and compensation for executives. Group of 20 countries collaborated to ensure greater surveillance of assets, liquidity, financial institutions and capital markets.
Such attempts to ensure transparency and accountability took place amid changes in views on the financial sector following the 2008 crisis. Blind faith in the free market mechanism of the financial market, prevalent since the 1970s, crumbled. Various studies indicated that an oversized financial sector did more harm to the global economy than good. In a recent report, economists at the International Monetary Fund said the financial sector can contribute to economic progress to a certain extent, but can damage efficacy of capital distribution and corporate productivity when it bulges out of proportion.
They observed there was too much finance in the U.S. and other advanced economies and the staggering pace of development and size was damaging growth. In an address to the American Finance Association last year, Luigi Zingales of the Chicago Booth School shared the same belief and argued that greedy rent-extracting by financial institutions not only shifted money from a large number of poorer people to a small number of richer ones, but could also gravely damage the economy.
While the role of governance and surveillance came under the spotlight in many parts of the world since 2008, Korea went in the opposite direction, heeding calls for deregulation and more freedom for the markets. Laws allowing bigger companies and the bringing together of financial institutions and industrial capital were passed. While financial integrity became the utmost value in the developed world, Korea went on loosening controls for lending, such as the loan-to-value and debt-to-income caps. Instead of containing greedy rent-seeking large financial institutions, there were voices calling for a giant industry leader like Samsung Electronics to go into the field.
These arguments are not entirely wrong. Korean authorities have been criticized for excessive meddling through various administrative instruments and verbal interference instead of regulating to ensure integrity and fairness. Their shadow control has impaired free competition in the market and development. Political motives were often behind the exercise of influence in the financial industry. Financial institutions had to grimly take orders to carry out various financing projects to meet political campaigns for the government despite their apparent risks. Supervisors often turned a blind eye to malfeasance and breach of antitrust in fear of dampening the economy and ended up contributing to the meltdown of the mutual savings bank industry in 2011.
What the country needs is stricter regulation and supervision in the financial sector, not deregulation. Korea is among just a few countries in the Organization for Economic Cooperation and Development (OECD) that lacks a convertible currency. Yet the country has a fully liberalized market, vulnerable to any external shock. Private-sector loans are way over the OECD average and household debt is among the highest in the world. More than a third of corporate debtors cannot pay interest with their operating profit. Korea needs stricter and more conservative guidelines to regulate lending than the international standard. Our bank’s capital ratios need to be higher than the international criteria. Foreigners hold more than two-thirds of Korean banks, and profits ultimately go to foreign investors. It is fine, but any bailout cost would be paid by local taxpayers in a crisis.
Supervisory administration should be more transparent to avoid unnecessary costs for financial companies, while regulation to ensure financial integrity needs to be strengthened. The supervisory authority must also be politically neutral. Such practices cannot be expected under the current supervisory system. The financial authority must be free of pressure from politicians, the media, government and the academic field. The head of the financial regulator usually serves for more than eight years in advanced countries while ours do not last a year and half. Monetary policy and financial regulation should be completely free from political influence. This is the most important fix needed in our financial industry in these turbulent times.
Translation by the Korea JoongAng Daily staff.
JoongAng Ilbo, June 13, Page 27
The author is an economics professor at Sogang University.
by Cho Yoon-je