Korea Case about banking

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FOREIGN PRIVATEEQUITY FUNDS IN

SOUTH KOREANBANKS

By Group EJayadhrita BanerjeeDeepika GontiaShivankur SharmaIsha WadhwaArindam BhattacharyaKaustubh Dalal


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Korean economyearlier!!

Since the 1960s, South Korea pursued anexport-oriented development strategy, wherethe growth of specific industries wasemphasized.

The government encouraged the import ofraw materials and technology to assist itsexport-oriented industries.

Domestic savings and investment were alsopromoted.

The government influenced the banksfinancing decisions, directing funds towards

large export-oriented companies atsubsidized interest rates.


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Government always interfered in theoperations of banks in South Korea.

Korea Exchange Bank, Korea Development

Bank and Korea Housing Bank were fullyowned by the government.

The government pressurized the banks tofinance the Chaebols activities, which

focused on growth rather than theprofitability of their investments. This led to ahigh debt-equity ratio .

The banks provided loans to these

companies with the understanding that thegovernment would rescue them, in case they


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The Korean Won was pegged to the US Dollar.

In 1997, the US dollar appreciated and,consequently, the Won appreciated as well,

resulting in an overvalued Won.The pegged exchange rate led to extensive

borrowing by domestic banks andconglomerates under the illusion that

exchange rate risk did not exist.


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WHAT LEAD TO THECRISIS???????The South Korean banks borrowed short-term

loans from international financial institutionsand lent them over long-term.

The domestic firms, which were alreadyhighly leveraged, also accessed foreignfunding to finance their projects.

The countrys total foreign debt amounted to

more than $160 billion by 1997, and a majorportion of this was short-term debt, whichwas repayable in less than a year.


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The Chaebols imported technology andmachinery for their risky projects.

A rise in imports and a fall in exports implied

the South Korean economy, which dependedon exports, now suffered trade deficits.

By 1996, South Koreas current accountdeficit was over $23 billion or equivalent to

4.5% of its GDP.


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THE CURRENCYCRISISThe Asian Financial Crisis, which began inThailand in July 1997, spread to Malaysia and

Indonesia.

The foreign investors fled the region, and theAsian currencies devalued against the dollar.

The currency crisis spread to South Korea,where the government spent precious foreign

reserves to protect the Wons exchange rate.The value of the Won declined from an

average of W804/US$ in 1996 to an averageof W1400/US$.


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When the Won was depreciated, the privatesector found it difficult to repay the foreignloans or the interest payments due on theloan denominated in foreign currencies.

Many of the Chaebols such as Kia, Jinro andHanbo Steel, which figured amongst the topthirty Chaebols in South Korea, collapsed andthe banks suffered from enormous non-

performing loans .


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THE BAIL OUT.

In the aftermath of the Korean FinancialCrisis, the South Korean governmentconstituted the Financial SupervisoryCommission and abolished the ceilings on

interest rates.

Other measures taken to guard against therecurrence of the financial crisis included theintroduction of international accounting

standards, implementing prudent bankingpractices.

In order to reduce the bad debt burden ofdomestic banks and corporations, the

government set up asset management


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The government invited foreign investmentin the troubled South Korean banks.

Non-performing loans were auctioned off to

foreign investors. South Korea became an attractive

destination for foreign direct investment, asthe depreciated Won and fewer bids made

assets cheaper. The foreign funds purchased distressed

South Korean banks at dirt-cheap rates andinjected much needed capital into the banks.


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THE BENEFIT FROMFOREIGN INVESTORS!!

Under private equityinvestors, the South

Korean banks were freefrom government

intervention.They financed those

projects, which the


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The foreign-owned banks had a positiveimpact on the local banks as the latter havefocused on profit maximization in order tocompete successfully with the former.

The banks, which prior to the financial crisisconcentrated on financing the Chaebols,focused on lending to Small and MediumEnterprises (SMEs) and households.

The foreign funds acquired the domesticbanks, restructured them and then sold themto strategic investors, who could not take therisk of restructuring ailing banks themselves.


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Good corporate governance, transparentbusiness, greater expertise, wider businessscope; these all came with the overseasinvestors.

There was a sharp difference in theperformances of foreign and domestic banksin South Korea.

In 2003, the 33 foreign bank branches saw a38.8% increase in their combined net profitby posting Won411, 000bn. The figuresbecome significant when compared with the63.4% decline in the net profit of the 19

locally-owned banks.


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HOWEVER.

The detractors of foreign private equity fundscontended that their main criteria forinvestment were short-term gains.

They argued that this quest for short-termprofit could drain South Koreas nationalwealth.

They maintained that the stability of SouthKorean financial markets was threatened bythe speculative nature of foreign capital andthat the government should restrict foreignownership of domestic banks.

Frequent inflow and outflow of foreign fundswill not only have a negative impact on the


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Some Korean economists were of the opinionthat the government should have spent a fewmore trillion Wons from public funds torescue the troubled banks instead of letting

speculative foreign funds acquire them; asthey believed that the former course ofaction would perhaps be cheaper in the longrun.

The Bank of Korea (BOK) also urged thegovernment to limit foreign ownership ofKorean financial institutions in response tothe large holding of foreign investors inKorean commercial banks.


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In order to ensure increased participation ofSouth Korean buyers, the BOK advised thegovernment to delay the privatization ofdomestic banks.


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DANGERS OF FOREIGNFINANCING.. MNC may enjoys high competitive

advantages over local firms that can destroylocal competition rather than promote it.

They may create uncertainty because foreignfirms control the country within it bycontrolling part of its industries.

They may not promote any development forthe nation's economic activities by simplysource their components from abroad. whichmeans the tey will drive local producers outof business.

Can drive out money from the economyrather than injecting it in the economy.


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SOLUTION STATED!!!!!!!

The only way to prevent foreigninvestment funds from taking overlocal banks is to increase their value

by boosting competitiveness. If so, foreign equity funds will not

show interest in Korean banks

because they cannot make highcapital gains through short-terminvestment.

Government intervention to controlthe inflow and outflow of forei n


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THANK

YOU

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Korea Case about banking