Crisis in the Banking System of Korea

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Table of Contents

Introduction
Roles played by a banking system to a countries economy
Why and how was the crisis of the Korean banking system?
How the banking system has reacted to the crisis and government support
Impact of problems of banking systems in a country
Conclusion and recommendation
References

Introduction

A banking system is an interconnection of many banks that are linked together by a uniform network to conduct the banking business.

The banking business was majorly derived from the concept that some individuals in the economy may have excess money while others may be in need of money, therefore banks basically accept deposits and also lend or give out loans.

The banking system of Korea is just one of the wider banking systems of the Far East Asia that have recently faced crisis majorly due to politics and bad governance.

Roles played by a banking system to a countries economy

The role of banking systems in any economy can never be underestimated since in today’s economies banks prove to be their backbones. The roles of the banking systems are not solely from the systems themselves but they derive them from the roles of banks.

The major role of banking systems is to accumulate savings through banks which are in turn translated into investments which again busts the economy.

The banking system has the central bank as the major player, followed by the commercial banks and non-bank financial institutions.

The major functions of the central bank are the formulation of policies that affect the whole of the banking industry, they also regulate the other banks most so the commercial banks and act as the supervisors of the commercial banks and their operations, their lending and borrowing.

They also advise them on viable projects that they can always undertake or invest their funds on. The central bank of a country allocates countries resources on the productive sectors of the economy through the use of the fiscal policy tools.

Central bank again employs the stability tools to control money supply in the economy and therefore controlled inflation and hence stability in the economy.

Commercial banks on the other hand have got roles that range between lending and accepting the deposits. They identify structure and extend the loans.

They act as supervisors of non-bank financial institutions who are always not allowed to accept deposits; therefore they play the role of money that they lend out to them.

Commercial banks also advice individuals on the kinds of loans available and the procedures of obtaining such loans.

Banks themselves help boost the economy by themselves being investors; they invest the excess deposits in a variety of portfolio ranging from stocks and shares to developmental projects like in the real estate.

Banks due to the emergence of risks that emanated from banks globalizing and internationalizing their operations have decided to devise risk departments in their organizations which are responsible for identification, classification and management of such risks that are likely to face financial institutions like the financial, inflation and foreign as well as exchange rates risks.

Why and how was the crisis of the Korean banking system?

The financial crisis that affected the banking systems in Korea originated from the failures that were initiated by the banks themselves.

The banking industry is a very pillar of an economic system of any nation an any instability that surfaces it is normal likely to destabilize the economy of any country or region and to afar extent even result into a crush or crisis of a better part if not the whole financial system of the said country.

The banking systems of countries differ from each and every country and therefore the causes of such failures may not at whatever cost be expected to be the same (Park, J. H. and D. S. Kim., 1998).

Failures are normally caused if there it becomes a negative impact on the sector of the economy that the country in question relies upon. Developing countries’ economies are widely supported by agriculture and therefore if there is a negative impact on agriculture then there would result into a crisis in it financial systems.

This was observed in the massive collapse of banks in the USA between the years 1982 and 1992; this was the period when America still depended much on Agriculture and when depression hit the sector almost all the banks had to undergo a crush.

The recent crush in that originated from the US was now not as a result of depression in the Agricultural sector but due to the bubbles that faced their well and massively developed financial systems composed of the stock exchange where stocks are traded as well as the capital markets who are the market regulators.

In the 1990s a series of bank collapse was also witnessed in Japan and this was found out to be as a result of negative change in the stock prices in the in the Japanese Stock exchange Japan having developed much of its financial system by then.

For the case of the crisis in Korea, it was very funny and even ironical. This is because the crisis and to an extent collapse of several banks in Korea happened at a time when all the economic sectors of Korea appeared to be doing well.

Inflation appeared to be under control, the GNP was reported by the department of economic affairs to have been doing well and the balance of payment as well indicated that exportation was far much ahead of importation and this meant a surplus in the net exports.

Then what would have brought about the crisis? The system of government in the Korea a country in the East of Asia is explained to be the major cause of the crisis faced by the banking system.

Due to rigid and unsatisfactory government policies that didn’t attract any trade, the foreign investors were scared away band as a result diverted away to other countries in East Asia like Japan as result of very attractive ventures in such countries.

Joon-kyung, K. (2008) argue that the exaggerated democratization which gave vast freedom to the commodity market even before fully developing its market to fully accommodate the trade in commodities.

This even went as far as promoting globalization in Korea without well developed financial structures to support international trade. The Korean domestic products were also still not at the stage of competing internationally.

The crisis in the Banking system of Korea was also caused by the weaknesses of its own financial system. The financial system of Korea at the time of the crisis was completely under the control and the manipulation of the business community in Korea apart from the government control.

The international financial regulatory framework was therefore so much not followed i.e. preparation of the financial statements was therefore not up to the recommended standards.

They were prepared at the discretion of the business community. The business community and the government also spoke the same language hence the government could not enforce any of its principles, rules and regulations on the evil deeds of the business elite.

Banks supervision in the Korea also was lacking and therefore banks could act as they wished which is very dangerous for the system as a whole and what do you expect? Crisis in the whole system.

Hartmann, P., S. Straetmans and C. de Vries. (2005) say in as much as the capital adequacy for the banks appeared so good since the banks had enough deposits held by them. In fact the finance and commerce chamber at one time reported a capital ownership by banks of over 75% both in equity and borrowing.

Despite a good capital holding asset management was still very poor. It is in the banking system where the assets holding by the banks could still be reported to be below 12% in Korea. The degree of bad assets was also still so high and this contributed to the high losses in the banking industry.

They earnings were also drastically affected due to the wide margins of losses experienced during the operations. Dividends by shareholders were also not issued for a very long time and the shareholders worth almost ran negative.

The amounts of non-performing loans were estimated at about 7.5% of the GDP of Korea and about 6.2% of the commercial banks borrowings from the central bank of Korea.

And according to international standards these kinds of loans according to the rates mentioned above could even double (Johnson, H. J., 1994 & Mayer, C. (1988).

How the banking system has reacted to the crisis and government support

The banking system being an industry that is composed of banks, borrowers and lenders is very sensitive and highly volatile (Kao, C., Liu, S., 2004).

Its volatility is also contributed to due to the fact that banks normally experience what is called a synergistic effect once any instability occurs in the system i.e. the effect of any change is felt equally across by all banks in case of any destabilization.

Greenbaum, Stuart I., and Anjan V. T.,(1995) suggests, the banking system in Korea could therefore only react by narrowing down their operations, trying through its systems to reduce the non-performing loan ratio to lower levels and improve their management most so the management of the bank assets to bust their generation of value to shareholders wealth.

The greater work would only be experienced on how to manage the rate of withdrawal by investors most so the foreign ones so as liquidity and level of capitalization is maintained.

The government on the other hand can only support initiatives that are already put in place by the banks themselves.

The government can therefore only come in by first of all strengthening the financial and corporate sectors of its economy by formation and implementation of sound principles, rules and regulations to help guide the financial and to an extent the banking system.

The restructuring of the above sectors is also meant to win back the confidence of the foreign investors who got scared away due to lack of independence in the financial system and the commerce sector (Gilbert, R. A., & Wilson, P. W., 1998).

The government can also come in to rescue by using both monetary policies to either increase or reduce money supply to the banking sector and the economy at large; expansionary fiscal policies can also be employed like reduced taxation and increased government spending, all these are developmental tactics which are geared towards busting economic development and by far mend the crisis.

To support liquidity of banks at the time of crisis the government can employ blanket guarantees towards bank debts both local and foreign; it can also nationalize some banks to ensure that their funding is done by the treasury.

Through effective communication and coordination, government guarantee, liquidity support measures and controlled policy formation and implementation the government is able to bring banks out of a crisis if not completely preventing such crisis before they happen.

Impact of problems of banking systems in a country

According to Cameron, R., (1972), problems instigated by a country having poor banking systems are quite a number and their impacts are so grave and run deep in the economy of such countries.

The impacts can result from both local operations as well as foreign operations as well. Freixas X., B Parigi and J.C. Rochet.(2000) add that locally a crisis of a banking system affects in broad terms the general economic growth and development; the key growth sectors that majorly depends on loans from the banks are slowed down due to such crashes since they can’t now access the capital that is needed to support their business activities.

Productivity is also reduced hence reduced output, the level of consumption goes down lowering the living standards of a countries citizens.

Unemployment will also crop up because firms are laying off their workers due to reduced activity. The cost of living goes up as a result of inflation in the consumable goods and services and social evils may result as the people struggle to make ends meet.

Internationally banking systems may face problems such as those on foreign exchange risks due to the ambiguous terms and conditions. Also they are likely to experience exchange rates risks, this may contribute to part of the losses realized by banks if the risks are not effectively managed.

Conclusion and recommendation

As we have seen above the banking sector is a very active and important if not fundamental aspect of any given countries economy; therefore it requires care and gist in handling it hence the stakeholders should always ensure this.

Berger. A. N. (1998) and Casserley, D., et al. (1999) argue that, this can only be ensured when: the levels of corruption and corrupt practices by the government are seriously reduced and sternly deal with in case they are detected; poor traditions and practices such as those on monopolization by locals for selfish gains and benefits should be avoided most critically in the banking sector, banks should be allowed go fully international through globalization. This ensures healthy competition and provision of quality services in variety to its consumers.

It is also recommended that banks which still have not instituted risk and disaster management departments in their organizations to do so since in as much as it may be slightly costly they are equally vital and necessary.

The necessity comes in the sense that it would help prevent future losses given an organization will be in a position to foresee looming crisis and make adequate arrangements to prevent their impacts in their banks.

Since banks are prone to lots of risks then effective and current risk management policies should always be embraced to ensure risk free operations by the banks.

A banking system is a very important and fundamental sector of the economy and therefore needs only care and maintenance in order to survive the hard economic times and withstand financial crisis in case they happen (Grosfeld, I., 1994).

References

Berger. A. N. (1998). The efficiency effects of bank mergers and acquisitions: A preliminary look at the 1990s data. In Y. Amihud and G. Miller (edt.), Bank Mergers and Acquisitions, Boston: Kluwer Academic Publishers.

Cameron, R., (1972). Banking and Economic Development’, New York, London: Oxford University Press

Casserley, D., et al. (1999). Banking in Asia: The End of Entitlement. John Wiley & Sons (Asia) Pte Ltd.

Freixas X., Parigi, B. and. Rochet, J.C., (2000). Systemic Risk, Interbank Relations and Liquidity Provision by the Central Bank. Journal of Money, Credit, and Banking 32(3/2): 611-640.

Gilbert, R. A., & Wilson, P. W. (1998). Effects of Deregulations on the Productivity of Korean Banks, Journal of Economics and Business 50: 456-478.

Greenbaum, Stuart I., and Anjan V. Thakor.(1995). Contemporary Financial Intermediation. Philadelphia: The Dryden Press.

Grosfeld, I. (1994), ‘Comparing Financial Systems: Problems of Information and Control in Economies in Transition’, CASE Research Foundation, Warsaw

Hartmann, P., S. Straetmans and C. de Vries. (2005). Banking System stability: A Cross- Atlantic Perspective. NBER Working Paper No. 11698

Johnson, H. J. (1994). Banking Regulation Today. Chicago: Probus Publishing Company.

Joon-kyung, K. (2008). Overview of Korean Corporate Restructuring since the Financial Crisis: Focusing on Profitability and Financial Soundness (in Korean) (Seoul: Korea Development Institute, 26 June).

Kao, C., Liu, S. (2004). Predicting bank performance with financial forecasts: A case of Taiwan commercial banks. Journal of Banking and Finance 28, 2353-2368.

Mayer, C. (1988). ‘New Issues in Corporate Finance’, European Economic Review.

Park, J. H. and D. S. Kim. (1998). Korean Financial Crisis and Reform: An Overview. Paper presented at the FMA Annual Conference, Chicago, US, 14-17 October.

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