By Chin Dong-soo
FSC Chairman
Over the past decade, the global economy has enjoyed an unprecedented boom period marked by financial innovation, low inflation and rapid growth. However, global imbalances and persistently low-interest rates led to rapid credit expansion and overleveraging, which subsequently created vulnerability in the financial system.
In addition, asymmetric compensation schemes and misaligned governance encouraged financial institutions to take excessive risks. Unfortunately, financial supervisors and regulations around the world fell short of delivering effective responses to such changes in the financial market.
Indeed, the global financial crisis served as a wake-up call for all of us; to deliberate on the future of the global financial system and to reflect on what efforts need to be made to revamp the current system.
The financial crisis that hit Korea and other Asian countries in the late 90's differs from the recent global crisis in terms of scope, depth and characteristics. However, the underlying issues are quite familiar in that both crises highlighted the need to restore stability in the financial system as well as the role of financial intermediation.
As known, Korea underwent a severe financial crisis in 1997. Perhaps because of the severity of the crisis, we were able to put in place a far-reaching set of reforms to our financial system that has shaped our subsequent recovery.
In this respect, I would like to share some lessons from Korea's experience in overcoming the Asian financial crisis.
First, we took bold steps to restructure insolvent firms - both financial and non-financial companies - to ensure that the recovery was based on strong foundations.
Second, we put in place special resolution regimes for the swift but orderly resolution of distressed financial institutions.
Where public funds were involved in the restructuring, we put in place rules for fair burden sharing between private owners and the government that balanced the need for supporting distressed institutions and the interests of taxpayers.
Third, we were acutely aware that the government's capacity to play its "last resort" role in the restructuring effort was only as good as its underlying fiscal strength. To that end, we made every effort to keep a tight fiscal ship.
We note that these findings provide some important lessons that can be universally applicable in measures to cope with the recent global financial crisis.
First, given the difficulty of a fundamental systemic reform, we must capitalize on the opportunity of the crisis while there is enough momentum.
Second, a resilient financial system and reinforced role of financial intermediation are integral to effectively overcoming the crisis and achieving balanced growth in both financial and real sectors.
Third, regulatory reform is sustainable when it is implemented at minimum cost, while ensuring fair burden sharing of stakeholders.
The international community has a shared consensus on the need for financial regulatory reform, promoting numerous discussions on many fronts. Yet core issues, including minimum capital requirements on banks, financial sector burden sharing, Systemically Important Financial Institution measures, are still under discussion.
As delayed decision-making can create uncertainty, it is crucial to finalize on the above core issues by agreeing on the basic direction and what will be specifically addressed in the reforms. This is also extremely important in maintaining reform momentum and ensuring the credibility of the G-20 as a premier forum for international cooperation.
The significance of the financial regulatory reform discussed at the G-20 lies in the recovery of balance between financial and real sectors. Meanwhile, emerging market perspectives should be reflected in the reform process, expanding the scope of financial regulation discussion.
Despite that recent global crisis oriented from advanced economies, volatilities in foreign currency liquidity have exposed Korea and other emerging economies without international reserve currencies to risks comparable to systemic levels.
Unless a global financial safety net is secured to supply foreign currency liquidity in times of crises, emerging economies will be exposed to continuous risk. This, in turn, will impede efforts to build a strong and sustainable financial system that we all aspire to attain.
This issue should be actively raised by emerging economies and requires a wider perspective to address this challenge on an international level.
It is crucial that financial reform should be carried out as means to overcome and prevent crisis. Equally important, however, is that reforms ensure that we go "back to the basics" to restore the original role of finance as an intermediary between savers and investors. Or as Joan Robinson famously stated this point of view in the most concise way: "Where enterprise leads, finance follows".
We hope that the G-20 Summits in Toronto and Seoul will derive consensus for global financial reform and expand the scope of regulatory discussions to effectively incorporate emerging market perspectives.