“Our problem is how to turn away financing officers from our good friends the foreign bankers without hurting their feelings,” said In-Young Chung, the Minister of Finance for the Republic of Korea.
His point was that the country’s foreign borrowing requirements this year will fall well below earlier forecasts. A year ago, the Bank of Korea, the central bank, estimated that the country would need about $00 billion in 1986. Now it may need as little as $00 billion.
Chung was probably aware of a touch of irony in his ebullience. He was speaking against a backdrop of unnerving political unrest in Seoul. There had been a spate of self-immolations by anti-government protesters, and the day Chung talked to Euromoney a left-wing sit-in was staged at a Bank of American affiliate in Seoul. Even with the slackening in recent borrowing requirements, overseas debt has hit a record $48 billion, putting the country among the world’s four biggest debtor nations.
In one sense, South Korea’s buoyant economy is bad news for Seoul’s community of foreign bankers. If Korea eventually reaches its target of financial self-sufficiency, they may lose their present pampered position.
Seung-Chul Ahn, president of the Korea Development Institute, said: “Korea has needed foreign banks to help it borrow abroad, so they have been encouraged to open branches here. Foreign bank branches are virtually guaranteed big profits on their won lending. A foreign bank here can be profitable in its first year. There are not many countries where that it true.”
On Chung’s count, the country is host to 52 foreign bank branches, compared to 26 a decade ago and 37 in 1981. Their total assets more than quadrupled, to nearly $6 billion in the five years to end-1984. Meanwhile the foreign banks’ reported profitability has been consistently way above levels available in most other markets. According to figures supplied by the Korea Exchange Bank, foreign banks in Korea earned a yearly return on assets recently averaging 1.5%. Although the figure is down from 1.8% in 1981, it is in marked contrast to the performance of Korean-owned banks. Seoul’s five major city banks, anaemic in recent years, showed return on assets as low as 0.2% in 1982 and 1983, before recovering to 0.3% in 1984.
What makes the more far-sighted of the foreign banks uneasy is that they are dependent on the authorities’ fiat for their profitability. Roderick Frew of Lloyds Bank pointed out that they are allowed virtually no access to local won deposits. Instead, they fund their won lending by complicated repurchase arrangements (known in Seoul as “swaps”) with the Bank of Korea, in which they import foreign currency from head office and get won in return.
They are indemnified against depreciation of the won and, under Korea’s tightly regulated banking system, they are allowed a specified spread in lending on to corporate Korea. Best of all, as the Korea Exchange Bank pointed out in a recent analysis, credit risk is minimized: foreign banks demand and receive a payment guarantee from either a domestic bank or from one of the chaebols — the giant conglomerates that dominate the Korean economy.
Many bankers feel they cannot count on the Bank of Korea’s repurchase arrangements forever. They reason that the system is partly a public relations effort to cultilate Korea’s country risk rating. If the country starts reducing its debt on schedule in the early 1990s, there will be no need for such artificial strategies.
The Bank of Korea has already moved to squeeze the foreign banks’ margins. Last year the margin on this kind of lending was reduced from 1 to 0.75%. And a cut to 0.5% was recently rumoured to be in the offing.
Talking to Euromoney, Bank of Korea governor Sung-Sang Park did little to reassure foreigners on the point. “From now on the foreign banks may have less business in swaps. We don’t like to build external debt that way.”
Several American banks which have big operations in Korea have been demanding “national” treatment, by which they mean gaining access to local deposits. “If we are to have a secure long-term future we want to compete on an equal basis with the Korean banks,” said Citibank’s Seoul corporate banking head, Ewan Copeland.
The Americans have been pressing to issue won CDs, a privilege now confined to Korean banks. Lloyds, whose Korean operation is the biggest among the British banks, is pushing for the establishment of an effective interbank money market. “There is virtually no money market here. There is no broking system and the rediscount system is hardly a substitute for access to local funds,” said Frew.
Korean officials have been anxious to assuage the foreigners’ fears. Finance Minister Chung said: “We are quite sympathetic about their worries for the future — particularly those banks which have committed themselves to Korea, have been here a long time and have invested a large amount of capital. In the long run, Korea’s overseas borrowing will decline, but we have a decade before things will really change for the foreign banks.”
Meanwhile, according to Chung, Korea is moving to give the foreign banks’ branches a stronger base. “It is a matter of time — we are progressing step by step,” he said. “The foreign banks are now members of the clearing system, for instance. They have been given access to our rediscount facility system for export industries. We have opened up the trust bank business to them. There is little discrimination left.”
Chung warned the banks that if they want full national treatment they may be biting off more than they can chew. “Are they proposing to accept the burden being shouldered by the domestic banks?” He asked. “If they are put on an equal footing there will be fewer privileges.”
This threat has put many foreign banks in two minds about national treatment. According to Ahn of Korea Development Institute, smaller foreign banks and recent arrivals are particularly chary of a change in the status quo. “The big banks such as Citi, Chase and Bank of America have a different interest from the newcomers from places like Singapore and Europe,” he said. “The smaller banks know they would face tough competition if this market is liberalized more.”
Another observer commented: “Many of the new arrivals come here just to take advantage of the privileges, and have no intention of staying here forever.”
James Todd, director of the Korean Merchant Banking Corporation, said: “Many of the smaller banks don’t want to rock the boat. In their view, publicly drawing attention to the artificiality of their situation could bring political pressure to curb their privileged position.”
Many of the bankers believe that, if the swaps system disappears, their Seoul branches will be left with virtually no won-based business. Dai-Ichi Kangyo’s Seoul branch manager, Satoru Yanagisawa, voiced the fears of many when he said: “We are worried that the position of the foreign banks here may go the way it did in Japan, where they did very well with their monopoly in foreign currency loans. But, Since Japan started liberalizing, the going has got a lot tougher for them. If we ask for too much in Korea we may lose something.”
Some banking observers maintained that even the big players were foolhardly in calling for a level playing field. “The experience of foreign banks in other parts of the world is that if they get free competition in a market like this they will eventually cut their own throats,” said Todd.
He pointed out that the government has been pressing the foreigners for quid pro quos in return for liberalization. The foreign banks have, for instance, been given access to a lucrative subsidy scheme for export credits which had previously been the sole domain of the domestic banks. But, in return, the foreign banks are now being required to expand their lending beyond the big names of corporate Korea. They are being asked to allocate at least 35% of their lending to small and medium-sized companies.
The requirement has caused anguish for many foreigners. One major American bank has flatly told the govenrment that it will meet its quota only when appropriate lending opportunities become available.
In the opinion of many Seoul observers, the problems of the domestic Korean banks are a major stumbling block on the road to liberalization. “Their miserable return on assets is hardly our fault, but it is a reasonable inference that their proglems have slowed deregulation,” said Frew. “They are in a weak position to stand up to direct competition from foreign banks.”
The Korean banks blame their problems on government directives over the years, forcing them to support over-extended industries. The biggest headache is Korea’s big overseas construction industry, which has been a major player in the Middle East. It was in trouble even before the recent oil price collapse, and is now a basket case. Another disaster for the banks is Korea’s world-beating shipbuilding industry, now in the depths of a global slump.
According to Dai-Ichi Kangyo’s Yanagisawa, the domestic banks’ non-performing loans are rumoured to total $4 billion. Tood of Korea Merchant Banking quoted estimates ranging as high as $8 billion. Their combined equity is only $2.5 billion. They have made minimal provisions. With total assets of nearly $20 billion, Korea Exchange Bank, for instance, provided less than $30 million last year for possible loan losses. As a vital division of Korea Inc, the domestic banks continue to function normally. Todd, however, observed: “In any other system they would have had to take write-offs. They would all be bust.”
Park forecast that the banks would recover within four years. “troubled borrowers in shipbuilding and manufacturing have a future,” he said. “They can improve with time and sound management, particularly in an economy like ours which is growing so fast. Shipbuilders can turn to making heavy equipment while the demand for ships is so low. The only real problem is overseas contracting, which is beyond our control.”
In the meantime there is less to liberalization in Seoul than meets the eye. Japanese bankers pointed out that access to trust banking is meaningless for them. “We are bound by Japanese Ministry of Finance rules which do not allow us to do trust business except through a separate subsidiary,” said Yanagisawa. “Our operation here is a branch, so we are blocked.”
For those banks which can enter the trust business, the prospect looks unexciting. Frew pointed out that trust banking, in Korean terms, means little more than being able to raise term deposits. “We accept gratefully, but that is not an answer to our ambitions,” he said. “Although we are theoretically able to do various things, in practice there are pressures, and certain intangible barriers are evident.”
The precariousness of the foreign banks’ position is compounded by the fact that they have achieved remarkable pentration in Korea. At the last count foreign bank branches had a market share in domestic lending of nearly 12%. As the Korea Exchange Bank pointed out in a recent issue of its monthly review, that is in marked contrast to Japan, where the foreigners’ market is a mere 2%. Even in Taiwan, which is at a similar stage of development to Korea, the foreigners’ market share is only 6%.
According to Ahn, their room for market share growth is severely circumscribed. “There is an implicit quotaM” he said. “We don’t want to be in a situation where our economy would be badly vulnerable if one day the foreign banks all decided to pull out.”
The foreigners are beginning to diverge in their strategies. Morgan Guaranty earlier this year decided to pull out of branch banking in Korea — and will concentrate instead on investment banking services which it believes it can render effectively from New York and Tokyo.
Citibank has also marked investment banking as an area for expansion, but will serve the market from Seoul.
Lloyds sees trade finance as a major area for development. “Our merger with Standard Chartered is an indicator of the way to go,” said Frew. “Korea is a trading nation, so there is a big market for trade finance if you are geared to provide an international service. It may take aggressive pricing to increase our market share, but we intend to do so.”