Korean Banking Sector in Crisis
Public Fund Injection Needed to Avoid Worst-Case Scenario
By Kim Jae-kyoung
Staff Reporter
With the country's money flow mechanism seriously impaired, the government is considering injecting public funds into the banking sector to shore up its capital base so that liquidity is available to cash-strapped local enterprises.
The extreme move came as a preliminary step to prevent a liquidity crunch here from turning into a liquidity crisis. The government has deployed all traditional tools, including monetary easing and fiscal spending, to no avail.
Despite the Bank of Korea (BOK)'s billions of dollars in liquidity supply, the local financial system has still been clogged with banks reluctant to lend to companies due to a weakening capital base, which has exposed the economy to a real crisis.
To raise necessary funds, the government is mulling over issuing additional state bonds of up to 20 trillion won and ask the central bank to buy them. It is expected to step up intervention in the banking sector in exchange for offering taxpayers' money.
Many are deadly set against the bailout plan, arguing that it is too early to resort to taxpayers' money and such support will create moral hazards among banks and companies.
However, global economists stressed that given that the banking sector, which is as important to the real economy as blood to the human body, has now effectively stopped functioning as a source of capital to the real economy, the move is a step in the right direction to avoid the worst-case scenario.
``The liquidity crisis in Korea is not as severe as experienced in the U.S. or Europe, but still the financial markets in Korea are not functioning and the banks require support in order to ensure that liquidity is made available to the corporate sector,'' Jeffrey Jones, chairman of Partners for the Future Foundation of AMCHAM, told The Korea Times.
``Without such support, we could not unclog the flow of funds to the corporate sector resulting in even greater economic chaos,'' he added. ``The real economy is in a crisis at the moment given the lack of any lending to the corporate sector.''
Market Force Company CEO James Rooney said that the banking sector has already been in crisis for three months now, since Lehman was sent to bankruptcy, noting that malfunctioning of the sector can be as disastrous to the economy as failure of blood flow would be to your body.
``In these circumstances, there is little that the government can do by using traditional tools of intervention. There is now a real argument that governments have to directly take over the role of banks in providing ordinary credit in the real economy,'' he said.
``This matter is extraordinarily urgent. If it is not resolved within a very short period of time, the economy, just like our hypothetical patient without his blood flow, will lose consciousness and start to seize up,'' he added.
In particular, global economists emphasized that Korea should try to find remedies in the context of the global situation.
``I think the policies being considered should be seen in the context of the global situation. The global crisis is affecting Korea's domestic economy. Taking all possible measures to avoid the worst-case scenario is the right thing to do,'' Hong Kong-based David Mann, head of Korea Research at Standard Chartered Bank, said via email.
``Once markets fail, as has happened globally, the government has to step in to avoid the problem spiraling. It could well help to avoid the worst symptoms of the crisis,'' he added.
Rooney said that although the problems were not started in Korea, the consequences are already impacting us deeply, citing the volatile currency market, the difficulties of banks in managing their credit from overseas, and the difficulty of exporters and importers getting trade financing.
However, international experts said that the government should not interfere in the bank lending practice in return for providing taxpayers' money.
``We have to be very careful in providing such support to avoid directing the banks to lend to specific companies or industries. This would be a return to market conditions that actually resulted in the financial crisis in 1997-98,'' said Jones, who is also an international lawyer at Kim & Chang, one of the largest law firms in Korea.
``If the government believes that certain companies are critical to the Korean economy, the government should consider some specific package for that company similar to that now under consideration by the U.S. in respect of the auto industry in the U.S.,'' he added. ``It is very dangerous for the government to impose lending conditions on the banks and will be counterproductive to getting the economy in a recovery mode.''
Mauro F. Guillen, director of The Lauder Institute at The Wharton School of Business, also said, ``The banks need to have the freedom to decide whether to lend or not. What the government can do is ensure that they have enough capital and that they meet capital adequacy ratios.''
``The government can use official credit institutions to ensure that firms that are important to the economy have enough working capital to fund their operations, especially those that are export oriented,'' he added.