KOREA Structural Reforms in the Financial & Corporate Sectors Progress and Issues

1. KOREAStructural Reforms in the Financial & Corporate SectorsProgress and Issues Sri-Ram Aiyer Country Director, Korea Department East Asia & Pacific Region The World Bank KERI, Han Kook Ilbo Seminar

2. MAIN ELEMENTS OF KOREA’S STRUCTURAL REFORM PROGRAM • Establishment of a sound, market-based financial system • Corporate sector reform to restructure corporate finances, improve corporate governance, and enhance competition • Reorienting the role of government from “dirigisme” to support of private activity • Improving labor market flexibility and strengthening social safety nets IN ORDER TO • Strengthen market economy and provide impetus for efficient allocation of scarce financial resources to high return activities • Lay a new foundation for growth better attuned to today’s economic imperatives, including globalization. KERI, Han Kook Ilbo Seminar

3. FINANCIAL SECTOR REFORM • Unified financial sector regulatory and supervisory body established, and functioning with increasing autonomy • Prudential regulations upgraded, forward looking criteria to be adopted for loan classification • Clear principles and processes adopted for use of public resources in financial sector restructuring/recapitalization • Established Korea Asset Management Company to manage and quickly dispose financial sector assets acquired by Government KERI, Han Kook Ilbo Seminar

4. FINANCIAL SECTOR REFORM • Speedy resolution of weak banks following diagnostic audits, through closure/merger/gov’t acquisition • Restrictions on foreign entry removed, two banks being sold • Resolution and restructuring strategy for non-bank financial institutions adopted • Upgrading of supervisory capacity and credit capacity of banks to begin KERI, Han Kook Ilbo Seminar

5. DEVELOPMENT OF CAPITAL MARKET • Drastic liberalization of regulations on foreign participation • Diversification and deepening of market through encouragement of new institutional investors (e.g. mutual funds) and asset securitization • Strengthening of securities market infrastructure– improvement of prudential rules, enhancement of market competition, improvement of financial accounting and disclosure, strengthening of market institutions • Development of bond market, including standardization of government bond issues and development of market-makers’ network KERI, Han Kook Ilbo Seminar

6. CORPORATE GOVERNANCE • Strengthening of responsibilities, independence and accountability of corporate boards • Enhancement of minority shareholder and institutional investor rights • Enhancement of creditors’ rights through improvements in bankruptcy laws and laws on secured lending • Adoption of accounting, auditing and reporting standards consistent with international best practice—for both financial and non-financial corporations • Enhancement of role of independent professional bodies in standard-setting and regulation in accounting and auditing • Introduction of audit committees of boards of directors KERI, Han Kook Ilbo Seminar

7. COMPETITION POLICIES • Strengthening of Fair Trade Act and its enforcement • Commitment to fully enforce competition laws in the restructuring of chaebols • Tightening of rules against transactions between related corporations and parties • Institutional strengthening of Korea Fair Trade Commission and increasing its sanctions powers • Removal of restrictions on holding companies • Major liberalization of foreign investment and M&A regime, including allowing hostile takeovers • Simplification of customs and certification procedures KERI, Han Kook Ilbo Seminar

8. CORPORATE RESTRUCTURING • Establishment of a framework for corporate debt workouts led by creditor banks under guidelines established by FSC and linked to financial sector restructuring • Debt workout process supported by policies to: • limit “emergency” loans • reduce cross-guarantees • limit concentration of credit • facilitate debt-equity swaps, asset sales, and M&As • remove tax disincentives • tighten regulations on intra-chaebol transactions KERI, Han Kook Ilbo Seminar

9. Closure of insolvent, non-viable corporations • Establishment of Capital Structure Improvement Plans for implementation and monitoring of restructuring by top 5 chaebols KERI, Han Kook Ilbo Seminar

10. THE PLUS SIDE • Structural reforms including enacting of legislation announced and pursued by Government with consistency and clear commitment, despite difficult economic and social conditions. • Complemented by consistent macro economic policy adjustments on fiscal and monetary side as economy stabilized and external position strengthened significantly, led by exports. KERI, Han Kook Ilbo Seminar

11. THE PLUS SIDE (Cont’d) • Led to restoration of confidence (e.g., Rating upgrades ) in early 1999. • Domestic demand has also picked up, another sign of public confidence • FDI and portfolio capital inflows registering record increases • Stock market booming • GDP growth forecasts being adjusted upwards monthly by Government and other analysts KERI, Han Kook Ilbo Seminar

12. THE FRAGILE ELEMENTS • Banks still holding large stocks of NPLs. • Early 1999: Gov’t. KRW 100 tril. Market KRW 120 tril. • May 1999: Gov’t. KRW 130 tril. Market KRW 160 tril. • All crises show that NPLs are a moving target • Forward looking criteria will require additional provisions ( est KRW 33 tril. while KAMCO / KDI have KRW 10 tril. left ) • SME forced to restructure in 1998, due to credit crunch • Most large chaebols (1-64) began restructuring in late 1998, with three of the top five unable to meet their end 1998 d/e target. KERI, Han Kook Ilbo Seminar

13. THE FRAGILE ELEMENTS ( Cont’d) • FSC announcement of creditor banks’ review of implementation of restructuring plans showed 23 of 59 chaebols ( 6-64 )as “unsatisfactory” or lower. Process so far has been of limited scope ( dominance of smaller chaebol ), and limited effectiveness ( financial or operational ) • Largest 30 firms account for 15 % GDP and 5 % of employment, but over 45 % of total financial assets Their loss making, unviable affiliates absorb scarce capital, leaving little for high rate of return activities, including SMEs. Exit is important to permit entry. Best way to ensure high quality, sustainable recovery is to let capital flow to investments with highest returns. KERI, Han Kook Ilbo Seminar

14. THE FRAGILE ELEMENTS (Cont’d) • How to speed up introduction of modern credit culture? ( e.g. quick sale of two banks ) • The NBFI sector - KRW 543 tril. at end 98, or 130 % of GDP, compared with KRW 577 tril. or 137 % of GDP in banking system- is excessively short-term oriented and held by chaebols through ownership and management controls. Are their allocation processes transparent? • Are corporate governance reforms being adopted uniformly? Is there enough transparency in most firms? KERI, Han Kook Ilbo Seminar

15. THE FRAGILE ELEMENTS (Cont’d) • Is disposal of KAMCO assets proceeding quickly enough to complete “resolution”? • Is access to credit the only impediment for SME development? • Alongside high unemployment, urban poverty has doubled since the crisis - Beside the safety net, is there any remedy other than high growth? KERI, Han Kook Ilbo Seminar

16. THE CRISIS ABATES • Last year’s concerns How far will Korea’s GDP fall? When will the recovery commence? • This year’s concerns The recovery is underway in Korea, and the rest of Asia ( e.g., Japan ) KERI, Han Kook Ilbo Seminar

17. KERI, Han Kook Ilbo Seminar

18. TO SUM UP • Are the underlying issues in the real economy solved in Korea? • Not yet. Took years in US. • Is Korea’s recovery of high quality and sustainable? • With continued restructuring and reform, especially in corporate and financial sectors, and changes in behavior (governance / transparency, competition / anti-collusion, value-addition ), • it can be sustained, given the track record, human capital base and the President’s visionary leadership; and • Korea could then become a leading influence in Asia KERI, Han Kook Ilbo Seminar