Korean Regulator Criticised for Failing to Probe Banks

South Korea’s financial watchdog came under increased scrutiny over its monitoring of savings banks after Prime Minister Kim Hwang Sik said it resisted probes by the state auditor into the lenders last year.

The Financial Supervisory Service tried to dissuade the Board of Audit and Inspection from examining savings banks between January and April 2010 for suspicion of improper lending, Kim told lawmakers today in Seoul. Kim was chairman of the state auditor at the time, prior to taking his current post in October.

“Our inspection faced very strong resistance from the FSS, which said they will do it on their own,” according to Kim. “They said a stringent probe will turn up too many problems, which may cause bank runs.”

The ruling Grand National Party yesterday proposed a probe by an independent counsel into savings banks amid growing speculation that regulators overlooked illicit activity at the lenders. Korean finance regulators have also angered investors with delays that are holding up Lone Star Funds’ sale of Korea Exchange Bank (004940) even as President Lee Myung Bak pushes for consolidation in the industry.

The Financial Services Commission, the state regulator, said last month it will postpone approval of Hana Financial Group Inc. (086790)’s planned purchase of Seoul-based Korea Exchange Bank until legal disputes involving Dallas-based Lone Star were resolved. The FSS is a privately funded agency that enforces regulations set by the FSC.

Corruption Scandal

“The savings bank crisis is evolving into a corruption scandal and that’s the last thing the Lee government needs right now, when it’s already losing its battle against inflation,” said Kang Won Taek, a professor of political science at the Seoul National University. “This may make it hard for the ruling party to retain its parliamentary majority next year.”

South Korea this year suspended eight savings banks, including Busan Savings Bank and its four units, after their finances deteriorated because loans for construction projects soured amid a real-estate slump. The government is seeking to sell seven of the lenders by August.

In anticipation of a general legislative vote in April and a presidential election in December 2012, Lee’s Grand National Party needs to bolster its popularity and tame inflation that has exceeded the central bank’s 4 percent target ceiling for five months straight.

Approval Drops

Lee’s approval rating has dropped to 27.1 percent from 45.5 percent at the end of last year, according to a survey conducted between May 23 and May 27 by Seoul-based Realmeter. The latest poll had a margin of error of 1.6 percentage point. Lee, 69, is in his fourth year of the single five-year term allowed by South Korea’s Constitution.

The Supreme Prosecutors’ Office on May 2 indicted executives at Busan Savings Bank affiliates on charges including accounting fraud and embezzlement. The prosecutors blamed “insufficient supervision” by the FSS for the failure to detect the lenders’ illegal activities.

The FSS faces “the biggest crisis ever,” Lee said on May 4 as he ordered reforms.

Allegations by the prosecutor’s office come as the FSS is tightening oversight of foreign banks’ securities trading to prevent rapid capital flows from disrupting markets. The regulator said this week London-based HSBC Holdings Plc (HSBA) and Paris-based Credit Agricole SA (ACA) were penalized for improperly outsourcing Korean branches’ derivatives trading to branches in Hong Kong.

Stern Punishment

Kim said today he rejected a meeting request from then FSS Chairman Kim Jong Chang to show the auditor’s “strong determination.” Relatives of managers at the targeted savings banks also tried to persuade him to call off the inspection, the prime minister said.

Former FSS Chairman Kim suspended his agency’s ongoing probe into Busan Savings Bank in February 2010 before resuming it a week later to buy time for the lenders to respond, KBS television reported last night. The FSS denied the report and said the temporary suspension was procedural in an e-mailed statement today.

“If any officials are found of wrongdoing, they should be sternly punished,” Prime Minister Kim said.

GNP lawmakers led by Chang Je Won submitted a bill to the National Assembly yesterday, calling for an investigation by a so-called “special prosecutor” into the latest scandal, according to the text of the bill on the parliament website. The bill comes as the parliament this week agreed to hold a separate hearing on the case.

To contact the reporters on this story: Bomi Lim in Seoul at blim30@bloomberg.net; Seonjin Cha in Seoul at scha2@bloomberg.net

To contact the editor responsible for this story: Peter Hirschberg in Hong Kong at phirschberg@bloomberg.net; Chitra Somayaji at csomayaji@bloomberg.net

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