Indian Institute of Management

– Ranchi
PGEXP : 2020-22
Page No. : 7
Recovery and the Way ahead:
The quick turnaround of the
South Korean economy was no
less surprising than its
sudden collapse after the financial
crisis in 1998. The speedy
recovery was supported by
the fast restoration of financial
stability due to early closure of
non-viable financial
institutions and quick resolution
of NPL. The swift
macroeconomic adjustment and
government bond markets also
played an important role in
expediting the
macroeconomic adjustment
process.
The downward spiral of a credit
crunch and corporate defaults
was contained
remarkably as companies faced
lower labor costs and alternative
financing sources.
Having been the major source
of corporate funding,
commercial bank lending
bounced back, thus helping to
contain the downward spiral.
The recovery of bank
lending to the private sector
was a result of capital injection
by the government,
unlimited deposit insurance, and
administrative intervention to
promote rollovers to
ailing companies.
The government’s role was not
limited to maintaining
commercial bank loans. It also
fine-tuned capital and equity
markets. The significant role of
payment reprogramming,
labour adjustment and
government intervention in the
markets leads us to wonder
whether the South Korean
recovery process addressed the
possible sources of the crisis
as the crisis theories do.
Lessons:
The turnout of South Korea
was more than the combination
of revival and growth in
external demand and
expansionary fiscal and
monetary policies. Often
unacknowledged is the impact of
wide-ranging structural and
financial-sector reforms,
some under IMF monitoring, that
South Korea was forced to adopt
in response to the
Asian financial crisis of 1997-98.
These reforms, including more
effective regulation and
supervision of financial
institutions and better
management of foreign
exchange
reserves, enhanced the South
Korean banking and financial
sector's ability to absorb
these shocks and recover quickly.
The South Korean experience
vividly underscores that
a healthy financial sector is the
basic of recovery in this age of
rapid global economic
integration. Without this,
economies will not only be highly
vulnerable to external shocks,
but also measures to mitigate these
shocks, including costly stimulus
packages, will only
be partially effective.
From the case we can enhance our
learning vide the following:
A. To prevent another bad loan
problem in the future, what
changes should be
made in South Korean Banks?
To prevent another bad loan
problem in the future, following
changes can be
made in South Korean Banks:
Recovery and Way ahead
The quick turnaround of the South Korean economy was no less surprising than its
sudden collapse after the financial crisis in 1998. The speedy recovery was supported
by the fast restoration of financial stability due to early closure of non-viable financial
institutions and quick resolution of NPL. The swift macroeconomic adjustment and
government bond markets also played an important role in expediting the
macroeconomic adjustment process
The downward spiral of a credit crunch and corporate defaults was contained
remarkably as companies faced lower labor costs and alternative financing sources.
Having been the major source of corporate funding, commercial bank lending
bounced back, thus helping to contain the downward spiral. The recovery of bank
lending to the private sector was a result of capital injection by the government,
unlimited deposit insurance, and administrative intervention to promote rollovers to
debilitated companies.
The government role was not limited to maintaining commercial bank loans. It also
fine-tuned capital and equity market. The significant role of payment reprogramming
and government intervention in the market initiated a wave of change in crippling
Korean Economy.
Lessons from the crisis
1) The first point relates to the sequencing of capital account liberalization. Korea’s
decision to liberalize short-term capital flows ahead of long-term capital flows was a
serious mistake. Korea should have realized that short-term capital flows are more
volatile than long-term. Korea believed that short-term capital flows are largely
related to trade financing. In this day of financial globalization, trade financing
accounts for only a very small part of international capital flows. Anyhow, by
liberalizing short-term before long-term flows, Korea accumulated far too much
short-term liability, which led to uncontrollable mismatches in maturity and currency
2) To prevent another bad loan problem in the future, following changes can be
made in South Korean Banks:
a) Loan giving procedures should be streamlined. Rather than giving loans on the
recommendations of Chaebols, it should be given based on performance of
company.
b) Rather than solely relying on bank loans as a measure to finance, equities market
or capital markets should also be given preference which would bring performance
pressure on companies and reduce pressure on banking system.
3) It is a good idea for South Korea to rely more on the stock market as a source of
corporate finance as well as from the perspective of Chaebols. As this will change the
structure of South Korean financial system and may affect the future direction of the
economy.
 Before the crisis South Korean economy relied heavily on the banking system

Reforms Undertaken by Financial Supervisory Commission (FSC)

A) Bank Restructuring-
 for channelling savings to industrial investment (Shown in the table below).
Because at that time stock market investors typically had no long-term
relationship with the firms in which they invested.
 Financing of South Korean Corporations (in %) –

Year Through Financial Trough Bond/CP Through Stocks

Institutions Markets
1989 37.80% 27.84% 22.99%
1990 40.52% 26.70% 12.46%
1991 46.41% 22.76% 10.66%
1992 39.70% 21.53% 14.31%
1993 36.27% 32.81% 15.51%
1994 46.30% 21.15% 15.53%
1995 33.69% 32.83% 15.27%
1996 31.65% 35.04% 11.41%
1997 38.18% 28.25% 7.87%

 But during the crisis the banking system and the chaebols, once viewed as the
means to rapid economic growth, came under increased attack.
 Policymakers, including those at the IMF, believed that the chaebols, with their
close connections to politicians and government officials, could get loans without
much resistance from banks.

4) Moral hazard poses a serious challenge in terms of a well-functioning financial

system is obvious. In terms of domestic regulations, I believe this challenge has been
adequately addressed, at least in the Korean context. I have, however, some doubt
as to whether this issue has been properly addressed in the international context.
From the headlong rush of investment into Asia by international investors in the
1990s, it is difficult to maintain the view that international investors were blameless.