Korean Financial Crisis Research Paper

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[. . .] They also conclude that a larger foreign bank presence associates with a lower profitability and a higher provisioning for bad loans by domestic banks." (Jeon and Miller, 2005)

V. The Asian Financial Crisis Impacts on Korea

The Asian financial crisis is reported to have "product the dramatic domestic economic crisis in Korea" (Jeon and Miller, 2005) however it is stated, "more fundamental factors also added to its severity." (Jeon and Miller, 2005) Specifically too much investment and borrowing overextended the corporate sector and commercial banks are reported as having "overused short-term foreign lending as a source of funds." (Jeon and Miller, 2005) Lastly, the "lack of transparency of balance sheets, income statements, and management practices all led to a crisis of confidence in Korean institutions." (Jeon and Miller, 2005) Jeon (2012) states that the Korean crisis "is believed to be more of a liquidity crisis rather than a structural crisis." Jeon (2012) additionally states that the role of the government in the Korea crisis was unique as the government "controlled the allocation and prioritization of resources and credit. The government also determined restructuring initiatives and took full control of reform agenda to correct its own mistakes and oversights during the post-crisis period." (Jeon, 2012) The neoclassical view would hold that the Korean government's role was "unfair and controversial" however; the reality is that the government's interventionist role "is considered to be one of the significant contributing factors for the so-called Asian miracle as well as the remarkable recovery from the 1997 crisis." (Jeon, 2012) Jeon (2012) additionally reports that Korea has a "culture of uniqueness and a long history of more than 4,300 years. A deep understanding of culture is essential for an accurate appreciation of economic and social changes, including crisis and reform." The example stated by Jeon is the "chaebols (family owned conglomerates), curb corporate bond markets (informal and high interest private loans), unique management-employee relationships and labor unions, compensation systems, the chaebol firms and suppliers' relationship with the promissory note market, localism and the importance of blood and alumni relationships." (2012) Stated as unique Korean features in crisis management tools are Koreas: (1) gold-collection campaign; (2() self-imposed salary reductions by employees; and (3) the tripartite agreement for burden-sharing among management, labor, and government." (Jeon, 2012) Stated four is the IMF conditionality "imposed in an array of reforms in the financial sector, corporate sector, labor market, and microeconomic policy implementations." (Jeon, 2012) Jeon reports that the Korean crisis and subsequent reforms is considered to provide more convincing evidence, than other crisis-hit Asian countries, of the ill-prepared, mechanical and culturally insensitive nature of the IMF rescue plan." (2012)

VI. Korea's Mistakes and Lessons

Stated as a primary challenge for developing countries, which characterizes the Korean economy, is "inadequate domestic saving in spite of their relatively high savings rates and how to finance the nation's economic development with foreign capital and saving." (Jeon, 2012) Capital inflows are critically needed for financing economic development tend to have some negative economical effects in that some of the capital goes to consumptions rather than investment and "increase aggregate demand, and create inflationary pressure." (Jeon, 2012) Jeon states that capital inflows serve to "appreciate real exchange rates and, consequently, generate a deficit in the current account." (2012) Large foreign borrowing and current account deficits serve to bring about an increase in the economical vulnerability to variations in international capital flows. (Jeon, 2012, paraphrased) Inducing more foreign borrowing in order to finance the deficits, which is comprised by short-term sources, which are volatile results in a higher level of vulnerability with foreign investors liable to overreact to any development domestically or internationally and thus their funds being quickly withdrawn. The result is that the capital inflows driving economic growth weaken the financial system and when the domestic banking system is weak this is worsened as the banking system cannot withstand the capital flow reversal. This is what occurred in Korea. While the macroeconomic performance of Koreas was mostly positive prior to Korea being hit hard in October and November of 1997, there were developments that were negative in other areas and specifically "the bankruptcies of chaebols and the increasing trade deficits. Subdued import demand and the plummeting prices of DRAMs." (Jeon, 2012) The chaebols bankrupted in the 1990s resulting in the account deficits, which reached $23.3 billion of 6% of GDP in 1996 and 1997. These deficits were reported as financed primarily by "foreign borrowing of banks and financial institutions along with portfolio investment by foreign investors to Korea." (Jeon, 2012) There was excessive investment in steel and automobiles combined with labor strikes serving to weaken the profitability of exporting firms as terms of trade worsened. These bankruptcies are reported to have weakened the financial system significantly and the Korean won appreciated while the result was non-performing loans. In addition Jeon reports "The exodus of foreign capital invested in Korean stocks and securities and the successive downgrade of Korea's sovereign rating by international credit rating agencies, such as Standard & Poor's and Moody's, exacerbated the confusing crisis situation. Abrupt and massive outflows of foreign capital from Korea made it problematic to maintain an optimal level of international reserves and sharply tightened the availability of external finance in the international financial market, which was already contaminated by Asian flu started in Thailand in July 1997." (2012) Reported as one of the most distinctive characteristics of the Korean model of economic development over the last forty years is the "government-business partnership." (Jeon, 2012) The primary benefactors of the government controlled credit allocation in Korea were the Chaebols as well as benefiting from financial liberalization policy and various export-promotion measures. (Jeon, 2012) In addition, there were some bail-out measures of chaebols that were nearly bankrupt that created "a false belief that the government would implicitly guarantee against their bankruptcy in any event." (Jeon, 2012) One of the primary contributing factors to over-investment, low profitability, and increasing non-performing loans was the nonmarket-based and high cost government-chaebol relationship and this led to the Korean crisis in November 1997. Jeon (2012) writes that the 'Sequence and timing of financial liberalization [was] ill-prepared and hurried." The following table lists the external debts, useable gross reserves, and debt-equity ratios of Korea.

Figure 2 -- Korea's External Debts, Usable Gross Reserves, and Debt-Equity Ratios

Source: Kihwan (2006)

As shown in the previous chart the government of Korea "discouraged long-term foreign borrowing by business firms as it required detailed disclosure on the uses of the funds as a condition for its permission." (Kihwan, 2006) In addition, short-term borrowing was viewed as financing that was trade-related and this did not make a requirement of strict regulation. Because of the incentives provided for short-term borrowing banks and business firms financed long-term investments with short-term foreign borrowings resulting in short-term external debts in the banking sector accounting for "61% of total external debts in 1996." (Kihwan, 2006) Government policy in Korea allowed for a rapid expanse in the number of financial institutions taking part in foreign currency-denominated activities in a short period of time and specifically in regards to merchant banks with an increase in their numbers engaging in foreign currency related activities in a short period of time. The number of merchant banks increased from six to thirty between 1994 and 1996 and most of these were chaebol-owned acting as the funding channel for investments by chaebols. These banks were engaged greatly in borrowing cheap short-term Japanese funds from Hong Kong and financed projects that were primarily long-term. IN addition commercial banks borrowed foreign short-term maturities in order to compete for business with merchant banks. The result was aggravated maturity and currency mismatches on balances sheets in the financial and business sectors of Korea. The result is that by the end of 1997 the total of short-term external debts is stated at $63.8 billion with only $9.1 billion in useable gross foreign reserves. Kihwan notes that the problems from mismatch resulted from "weak prudential supervision. The accounting and disclosure standards expected of financial institutions were below international best practices, and market-value accounting was not widely practiced. Due to weak financial supervision and high chaebol dependence on bank financing, risk was concentrated on banks. Furthermore, chaebol leverage was extremely high…" (Kihwan, 2006)

VII. The Contagion Channel Examined

Reported as a remarkable feature of the Asian crisis is the pace at which this crisis spread beginning in Thailand the region's other countries. Varying explanations and proposals exist for how it is and why it is that this spread so rapidly in the region and specifically the "macroeconomic similarities, trade links across countries and cross-country financial links." (Kihwan, 2006) Stated as well is that careful examination of "macroeconomic indicators around the outbreak of the currency crisis in the crisis-stricken nations reveals the relative irrelevance of the strength of macroeconomic fundamentals with the eruption and contagion of the 1997… [END OF PREVIEW]

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Korean Financial Crisis.  (2012, April 10).  Retrieved February 15, 2019, from https://www.essaytown.com/subjects/paper/korean-financial-crisis/7043762

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https://www.essaytown.com/subjects/paper/korean-financial-crisis/7043762.