Nearly three years after Asia's financial crisis began and some $83 billion in relief later, South Korea's banks are still in trouble. The government says the financial system is burdened with about $80 billion worth of bad loans. That's a conservative estimate--$100 billion is more realistic. A survey by Sogang University economist Nam Joo Ha in July revealed that 1 in 5 Korean manufacturers didn't make enough money to service its debt last year; in all, corporate borrowing totals about $530 billion. "The debt bomb hasn't been defused," says Park Kyung Suh, finance professor at Korea University. And the government isn't moving quickly enough to do so.
Consider Hanvit Bank, Korea's second-biggest commercial bank. It is a primary lender to 25 of the 59 largest chaebol. Some 23% of its $48 billion in loans are now categorized as substandard, and more than 10% haven't paid interest for at least three months. The situation is no different at the three other major lenders to the conglomerates--Chohung Bank, Korea Exchange Bank, and SeoulBank.
NOT QUITE RIGHT. The government isn't ignoring the problem. It plans to spend $18 billion this year and $9 billion next to support the financial system. A second round of restructuring that will include the creation of a holding company to group together weak banks is in the works. And Seoul has pledged to let failing businesses fail--instead of propping them up just enough to prevent them from defaulting. Noting Seoul's commitment to bank reform, Moody's Investors Service upgraded the ratings of eight Korean banks on July 23; Hanvit, Korea Exchange, and Chohung now have the highest non-investment grade.
All the same, the government doesn't have it quite right. The $27 billion it will use to buy more bad loans isn't enough. "The banks probably need between $36 billion and $45 billion in the next year," says Nam. "The government earlier underestimated the size of bad loans, and that's why the banks are still suffering." Indeed, it was local creditors--not the government--who agreed on July 24 to buy about $4 billion of unsecured Daewoo Group loans from foreigners at a 60% discount.
Second, Seoul has told banks to set aside provisions of anywhere from 2% to 50% of their questionable loans by December. But that keeps the bad loans on the banks' balance sheets. And it means they will have less money to lend, especially since most have to raise cash to meet capital requirements laid down in 1998 by the government and the International Monetary Fund. Hanvit, for example, is even considering selling bonds that pay 14% interest--nearly 5 percentage points more than it can earn by lending to clients.
Korea doesn't have time for costly mistakes. Economists say Seoul has less than a year to fix the financial system and avoid a severe recession. Although the presidential poll isn't until 2002, politicians will probably play safe for a good year ahead of the elections. Few want to face voters angry about business closures and layoffs.
Korea doesn't face an immediate currency crisis, of course--it has built up foreign-exchange reserves of more than $90 billion since 1997. The economy grew at an annual rate of 10.9% in the first six months of this year; the central bank figures the rate will be at least 7% in the second half. And Seoul, which owns huge stakes in many commercial lenders, won't let the banks collapse altogether.
Yet there are signs that a liquidity crunch is looming. The corporate bond market has remained comatose since Daewoo Group failed last July and exposed the fragility of the country's investment trust companies, the major buyers of corporate bonds. Companies can forget about equity financing, too. The Seoul stock market is in the doldrums after falling 28% this year. And banks are doing little new lending. The crunch, if prolonged, will prevent companies from making the investments they need in order to remain globally competitive.
Rescuing the banks will be expensive. And letting weak companies fail may become a political liability for the government. But the longer it waits, the higher the costs will be.