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Opinion pieces on business & economic issues

KIM Yong-Ki

Troubling Practices of Korea's Banks

KIM Yong-Ki

Sept. 21, 2005

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For the first time in history, Korea's commercial banks are lending more money to households than to business companies. A central bank figure shows that outstanding household loans reached 293 trillion Won at the end of the first-half period of 2005. That exceeded loan balance to the corporate sector totaling 287 trillion won.

According to Korea Deposit Insurance Corporation, commercial banks also attained a record-high profit of 6.4 trillion Won in the same first-half period of this year.

On the surface, nothing seems to be wrong with these numbers. But think again: should banks do more lending money to households than to business companies?

Some commentators insist it's hard to fault banks for focusing their lending to households rather than to the corporate sector. After all, isn't making money the bank's principal business line? What's wrong with lending to households, considering the fact that most of the lending to the corporate sector turned into bad assets during the 1997-98 financial crisis period?

Moreover, the Korean government is unwilling to bail out any commercial bank with taxpayers' money due to its budget constraint. It is argued, therefore, banks now must improve its profitability through its own restructuring effort. They can no longer expect the government to rescue them from bad management.

But there is a plenty of skepticism over the way the banks make big profits. Is it right for commercial banks to score a 6.4 trillion Won profit by lending more money to households than to business companies? Does it not raise a moral question?

Samsung Electronic is a leading South Korean corporation boasting nine products that have the biggest market share in the world. It depends 80% of its sales revenues to the overseas markets. According to a recent edition of the US business magazine Fortune, Samsung Electronic has become the world's leading information and communications company with a net income of US$9.4 billion last year, topping IBM (US$8.4 billion), Microsoft (US$8.1 billion) and Intel (US$7.5 billion).

And yet, its first-half profits for 2005 amounted to a little over 3 trillion Won, less than a half of what Korea's commercial banks scored in their combined profits by catering to domestic businesses, and mainly dealing with household lendings.

Some analysts believe this can be an unfair business. They maintain that Korea's commercial banks had hogged profits at the expense of corporate and household profits. In other words, some of these profits could have gone to households or business companies.

Banks generate their income on the spread between lending and deposit rates and services fees charged to customers. They are guaranteed a measure of income source through the government's intrusive monetary policy and licensing schemes that prevent any promising competitors from entering the sector.

If they fell into a liquidity problem, the Bank of Korea is ready to play the role of the lender of the last resort. Deposits with banks up to 50 million Won are guaranteed by Korea Deposit Insurance Corporation.

All this anomaly, which cannot be found out in non-financial sectors, has been justified in the name of maintaining public good. People have entrusted to the banks important public responsibilities like the public use of private savings, efficient allocation of financial resources, and proper investment in infrastructure in the hope that they will contribute to stability and growth of the national economy.

But in reality, the role of Korea's commercial banks has been quite controversial. They have mostly encouraged individuals to take out imprudent loans, thus helping to precipitate the bursting of "plastic card bubble" in 2003. As these banks abruptly began recalling loans on massive scale, exacerbating the recession, they led to a string of corporate bankruptcies. In the process, the banks have helped to create no fewer than four million delinquent creditors unable to pay their credit card loans.

Today, some of these same commercial banks face accusation of triggering another speculative bubble in the form of property market boom. These controversial banking practices hardly do justice to their claims of being a corporate institution with public interest in mind.

Some argue that all this is a temporary phenomenon understandable during a period of slow economy. They maintain these anomalies will decline once business recovers and the banks resume their lending to business companies.

That may be an overstatement. In the past eight years since the outbreak of the Asian financial crisis in 1997, Korea's banking institutions have been enthusiastically reducing their exposure to business companies. In particular, a bank controlled by a private equity fund has recently recalled massive loans faster than others, especially from those small and medium-sized enterprises struggling to stay alive. Due to their inexperience in lending to business companies during the last eight years, it is dubious for the banks to display their ability to manage corporate lending even when the economy recovers.

So long as Korean bank executives delude themselves into thinking that they possess advanced banking practices even when they actually apply uniform yardstick on all their borrowers, their business will go nowhere. We need urgently to ponder how really we can reform the banking industry that has fattened itself at the expense of corporate clients, while silently profiting under all the privileges bestowed upon by regulatory protection.

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