Financial Reform after Crisis

Financial reform (금융개혁/金融改革) to overcome the Asian currency crisis was the first and foremost task that the Korean government and the financial industries have been assigned since the end of 1997.

Though some of those policy measures were demanded by the specialists dispatched from the International Monetary Fund (IMF), others were partly being implemented for the advancement of financial system during the 1990s.

Key words
financial reform, IMF Crisis, deregulation, reinforced regulation, financial infrastructure

Background
Since the 1990s, Korea had been carrying out a variety of measures designed to develop its financial system, but before fully accomplishing financial liberalization and greater openness it was forced to suffer through the currency crisis of late 1997.

This occurred because financial liberalization and openness were being promoted in the absence of appropriate financial infrastructure, and excessive competition between financial institutions led to a reckless inflow of capital and excessive lending.

The management of financial institutions as a result eroded, and the financial reforms conducted from 1998 were focused on enhancement of the financial infrastructure in order to speed up the restoration of sound management at financial institutions and simultaneously bring about the positive effects of financial liberalization and openness.

Gists of Financial Reform
Firstly, insolvent financial institutions were resolved through methods such as liquidation or mergers and acquisitions, based upon judgments as to their survivability. As a result, the number of banks fell from 33 in late 1997 to 19 in June 2005.

The number of merchant banks, meanwhile, which had once been almost 30, was reduced to just two at that point, with most of them having been liquidated due to poor management. This was also the fate of many financial institutions targeting the lower income brackets, such as mutual savings banks. Through this process of financial institution resolution, the government raised and then injected public funds worth around 160 trillion won and took a leading role in determining the survivability of financial institutions and selling insolvent ones.

At the same time, the government worked actively to enhance the financial infrastructure in order to allow the ongoing efforts for financial liberalization and openness to produce the expected results.

Regarding greater financial openness, measures to liberalize foreign currency exchange were enforced in December 1997, by transitioning from a managed floating to a free floating exchange rate system and through the all-out deregulation of overseas remittances. Meanwhile, the limits on foreign investment in stocks were lifted in May 1998.

Financial Deregulation
In addition, an easing of regulations was carried out through expansion of the scope of services able to be offered by financial institutions, together with liberalization of interest rates. To reinforce the competitiveness of financial institutions and permit more diverse financial services, regulations on the services they were allowed to provide were relaxed considerably.

In 2000, the Financial Holding Companies Act was enacted. Banks were authorized to sell beneficiary certificates in September 1998, and in August 2003 bancassurance, or the Bank Insurance (방카슈랑스) Model, was introduced. In January 2004, the Indirect Investment Asset Management Business Act was enacted, promoting the sale of indirect investment securities and expanding asset management by indirect investment agencies.

There occurred a simultaneous easing of the criteria for establishing financial institutions such as insurance companies and securities firms, and of the regulations on asset management and branches. In December 2004, by abolishing regulations on demand deposit interest rates, implementation of the Four-step Interest Rate Liberalization Plan begun in 1991 was finally completed.

Reinforced Sound Banking
To prevent flawed management at financial institutions from reappearing, regulations regarding sound financial institution management were tightened.

After the Prompt Corrective Action (PCA, 적기시정조치) System was imposed on banks, merchant banks and securities firms in April 1998, the system was gradually expanded to cover insurance companies (June 1998), mutual savings banks (December 1999) and credit unions (December 2003).

Following reinforcement of the criteria for classifying the assets of financial institutions based upon their levels of soundness in July 1998, a minimum period of three months of overdue payment replaced the previous six months as the criterion for assets “requiring caution”.

In January 2000, the Forward Looking Criteria (FLC, 자산건전성분류기준) System, a system for classifying assets according to their levels of soundness taking into account the future repayment capacities of borrowers, was introduced to banks. It was later also applied to merchant banks (June 2000) and to insurance companies (September 2000).

Reshaped Financial Infrastructure
Next, as part of the drive to increase management transparency and ensure a more responsible management system, the accounting and disclosure systems at financial institutions were reinforced. In November 1998, the reliability of accounting systems was elevated by a shift of the methods for evaluating securities owned by financial institutions to a fair-value basis, and the disclosure period for accounting information and management reports on banks, securities and insurance firms was reduced from one half-year to one quarter (January 2000).

The same was later done for asset management companies (January 2004). In January 2005, a securities-related class action system was introduced as a measure facilitating relief against damages caused by the falsification of disclosure documents, use of insider information or market manipulation.

Furthermore, in order to encourage the emergence of sound financial capital and promote responsible management at financial institutions, efforts to improve the ownership and governance structures of financial institutions were undertaken.

In April 2002, the Banking Act and the Financial Holding Companies Act were revised, to ease restrictions on the ownership of financial institutions through changes such as a raise in the percentage limit of individual possession of a bank’s or bank holding company’s voting stock from four to ten percent.

In 1999, to prohibit major shareholders from exercising undue influence, stricter regulations on the trading and granting of credit to major shareholders were imposed. The criteria for a financial institution becoming a major investor and its minimum capital requirements were also specified.

In January 2000, to improve the existing external audit system, an obligation was imposed on banks and merchant banks, as well as at securities firms, insurance companies and asset management firms of minimum sizes or larger, to introduce board systems centered on outside directors and install audit committees.

Overhauling Capital Markets
Meanwhile, in the capital markets, the opening of the Korea Futures Exchange took place in April 1999, and of the Free Board (the "Third Market") for trading over-the-counter (OTC) stocks outside the Korea Stock Exchange and the KOSDAQ (Korea Securities Dealers Automated Quotation) market in March 2000.

In addition, the Electronic Communication Network (ECN) was inaugurated in December 2001, enabling transactions in 250 types of stocks traded on the KOSPI and KOSDAQ exchanges after the closure of those two standard markets.

In January 2005, the Korea Stock Exchange, KOSDAQ and the Korea Futures Exchange were united into the Korea Stock and Futures Exchange, which was renamed the Korea Exchange (KRX, 한국거래소) in February 2009.

Furthermore, a succession of systems designed to facilitate the raising of funds through direct financing were introduced: the Asset-backed Securities (ABS) System (September 1998), the Corporation-type Investment Beneficiary Certificate System (December 1998), and the Mortgage Loan System (April 1999).