Financial Policy

Financial sector reform

As in the corporate sector, financial sector reform had two objectives; on the one hand, normalizing the financial system as fast as possible through restructuring, and on the other, rebuilding a financial safety net to prevent future crises.

First, to normalize the financial system, the government planned a speedy state-led restructuring of financial institutions. Those institutions capable of creating systemic risks (e.g., large banks) were reorganized with capital injections. To minimize moral hazard and to maintain market discipline, the incumbent management was removed, existing shares were retired, and employees were laid off. On the other hand, those posing little systemic risk (e.g., small banks and merchant banking corporations) were wound down.

Second, to rebuild the financial safety net, a consolidated regulatory agency with oversight on the banking, securities and insurance industries was created. In addition, prompt corrective action was introduced. The criteria for non-performing loans became much more stringent, and Korea Asset Management Corporation was established in 1999 to purchase and dispose of the impaired assets of financial institutions.

In May 1998, financial sector restructuring funds of 64 trillion won were raised in afirst round of bond issues. The second round in December 2000 added 40 trillion won to the pool of funds available for the purchase of impaired assets, recapitalization, and repayment of deposits of viable financial institutions. In addition to bond issues, the government resorted to other funding sources such as international lenders, state property holdings and public funds to raise atotal of 168.3 trillion won, which was equivalent to 35 percent of GDP in 1998.

Source : SaKong, Il and Koh, Youngsun, 2010. The Korean Economy Six Decades of Growth and Development. Seoul: Korea Development Institute.