Seven Korean savings banks have recently been ordered to suspend business. Observers are seeing the situation as a natural outgrowth of the financial authorities’ incorrect policy, reckless management on the part of banks themselves and moral laxity among consumers.
Between July and August, the supervisory office checked every savings bank in the country in a bid to improve their overall financial soundness. A total of 338 employees were mobilized from the Financial Supervisory Service (FSS), the Korea Deposit Insurance Corporation (KDIC) and some accounting firms. The size of the investigation is unprecedented in Korea.
As a result, the seven – Tomato, Prime, Ace, Daeyeong, Parangsae, Jeil and Jeil 2 – were forced to halt operations, while a further six were ordered to take voluntary steps for management improvement, with prompt corrective actions being postponed. The authorities recommend savings banks whose BIS ratios are lower than 5% but 3% or higher, to be subject to amelioration efforts, and imposed suspensions on those with ratios below 1%. Those found to be between the two ranges were strongly advised to normalize their business.
On hearing the news of the discontinuation, depositors collected petitions and staged rallies, yelling at the banks and the competent authorities, while the government and political circle announced an investigation to find out who should be responsible. A joint investigation team was set up to that end on September 22, including personnel from the prosecution, police, National Tax Service, FSS and KDIC. The team investigated banks’ main and branch offices, as well as the houses of executives and major shareholders, placing some under arrest.
Myth about Safety of Savings Banks
According to recent audit reports, six out of seven major savings banks with assets under management of two trillion won or more are running a deficit of 621.1 billion won; 56% of the total deficit of Korean savings banks. For example, Tomato Savings Bank was the second largest with 4.45 trillion won in assets as of the end of last year. Meanwhile, Jeil was the only listed company among them. Excluding these, three out of the six that could evade the suspension order at this time are in a group consisting of larger banks.
Until recently, such banks were focusing only on getting bigger through project financing (PF) investments and the acquisition of peers, dreaming of becoming a financial group or leading local. However, since the global financial crisis, this has become a pipedream. These banks have seen their profit sources go up in smoke, stranding themselves in the twinkling of an eye.
Their predecessors are mutual savings and finance companies. In the past, when there were no restraints on major stakeholder ownership, they could avail themselves of institutions’ funds by joining the management. As such, they were extremely prone to corruption. They renamed themselves mutual savings banks and then savings banks, increasing their credit lines and attempting to build consumer trust. Nevertheless, their competitiveness was limited between commercial banks and private lenders, being forced to find their breakthrough in real estate PF.
What has the Government Done?
Early last year, an accounting firm noticed irregularities at some savings banks, including the provision of illegal loans, yet authorities had no idea about such practices before the recent checkup. This is why many are holding the government responsible for the current situation. “When a monopolistic supervision is in place, things may be overlooked frequently,” said an industry insider, adding, “Superintendence making much of stability cannot satisfy the needs of the industry, in which efficiency matters.” The supervisory office’s two-track policy has also faced criticism. Following the Asian financial crisis in 1997, it focused on protecting the scope of business of commercial banks. Although it also drew a line to guard the scope of savings banks, it drove them to take over their less viable colleagues through M&A. In 2005, it even revised regulations so that savings banks with a BIS ratio of over 7% could acquire others. As such, banks rushed to enlarge themselves, with authorities doing nothing to rein them in. As can now be seen, the result has been devastating.
Savings Banks Reshaping Survival Tactics
At present, a total of 89 savings banks are operating in Korea, with 33 of them being in impairment of capital, and 6 beyond redemption. This means that more savings banks could be shut down in time, and that the large-scale diagnosis was not sufficient to fully tackle the problems, the two gravest of which are maturing subordinated bonds and distressed PF debts. Banks have to repay subordinated bonds and attract capital for the sake of BIS. The PF allowance is also hanging heavy on them. The seven suspended banks all failed to deal with the burden following the accumulation of reserves.
Meanwhile, the liquidity concern related to deposit maturity seems to be rather subsided. In 16 of the banks, approximately nine trillion won in deposits, more than 40% of the gross amount, reach maturity starting from November. This fact fueled fear of a bank run. As a countermeasure, the FSC is planning to amend the law so that it can halt the business of those expected to have a liquidity problem. At the same time, it intends to create a new clause stipulating that transaction details be reported in real time when 1% or more of a savings bank’s total deposit is withdrawn.
Savings banks, on their part, are trying to make themselves more profitable by curtailing deposit interest rates. 48 of them have adjusted the rates downward by a quarter of a percent over the last two weeks. Authorities are seeing this as a part of the process in which banks recover their asset soundness for the sake of survival. Currently, the difference between the rates of commercial and savings banks is roughly one percentage point, though it was close to double until recently.
The current savings bank crisis can be attributed to dog-eat-dog interest rate competition, the excessive concentration on risky PF loans and the authorities’ failure to stop it, and depositors opting to open high-risk accounts only to increase income. They should never forget the basic principle of high-risk, high-return. “The policy failed, the banks were slack and depositors were morally reprehensible for the rise of the disaster,” said a supervisory officer, adding, “Depositors would find it wiser to distinguish viable banks from insolvent ones before putting their hard-earned money in them.”
Where Will the Suspended Seven End Up?
The nation’s four financial holding companies, along with securities and insurance industry players, are showing a keen interest in acquiring the halted savings banks as most of their main offices are located in the capital. “not only is the takeover supposed to be in progress on a purchase and assumption basis, but it fits well with national policy demanding we shore up our small-loan financing side,” said a city bank employee. If the savings banks are included in the banking sector, people with low credit ratings may borrow money at lower interest costs because the savings banks can narrow the wide gap between the lending rates of the sector and third-tier institutions.
In the meantime, some private lenders have declared their intention to join the takeover battle. In doing so, they are intending to rid themselves of their negative image as a group of loan sharks, while turning themselves into institutional consumer financing groups. Such a move can also be a nice profit maximization strategy, since they can save financing costs once they are allowed to take deposits.