Sunday, February 20, 2011

Does a Bank Run Loom in Korea? Probably Not, But....

The Largest Savings Bank in Korea Has Closed
The Wall Street Journal has reported what Koreans already know: savings banks in Korea are in trouble.  This past week, 4 savings banks, including the nation's largest, were seized by the government.  The reason?  People who had their savings in those banks have withdrawn their money, and that has led to greater fear by the remaining depositors.  The result?  More people withdraw their money, and a vicious cycle begins.  This is known as a "run on the bank."  On Sunday, February 20th, the Korea Herald published this story regarding fear of a bank run (after the Seoul Gyopo Guide's original post yesterday).

Run on the Bank is a Comment on Koreans' Confidence in Government
Much like the United States, Korea has a deposit guarantee corporation, called KDIC.  It insures peoples' deposits in banks (for normal savings accounts).  The fact that this didn't matter, and depositors wanted to withdraw their money is a partial reflection of people's fear and lack of confidence not only in the bank itself, but it also points out that people have little confidence in the government who is insuring the deposits.  In Korea's case, this is a symptom of a systematic problem.  That problem is that everyday Koreans are largely distrustful of large, authoritarian entities.  This is quite interesting.  On one hand, democracy is quite young in Korea, and the legacy of mistrust from authoritarian regimes is understandable.  On the other hand, many Koreans' wealth is due, in large part, to the performance of the largest corporations, otherwise known as chaebol.  If you observed that this is also the case in other developed democracies, you may very well be right, which would suggest that Korea is quite developed indeed.

Savings Banks' Problems Now, Credit Card Problems Redux?
The underlying problem is implied in the Wall Street Journal article.
The suspensions come as the government tries to head off risks of systemic shocks caused by distressed savings banks, which are suffering from their exposure to the weak South Korean real estate market.
The fact is that the residential real estate market is suffering.  Inflation, on the other hand, is rising.  That has pressured Korean consumers.  In 2003, many Korean credit card companies were forced to be merged into their parent companies.  In addition, some credit card companies failed.  Part of the reason for the extensive use of credit cards in Korea is the tax benefit of using credit cards.  If you go to an apartment complex, there is usually a board for announcements and advertisements.  They are littered with home equity loan advertisements from finance companies.  With the cost of living rising, and the value of the largest asset, the home, declining, it is worrying that the savings bank industry is also under duress.  Whether or not the savings banks' difficulties will spread to the finance companies or another credit card crisis is yet to be seen.
Project finance is another area of concern to the savings banks in Korea.  Given that the largest corporations borrow from the largest banks (and international banks), that leaves construction loans, etc for the savings banks which are more locally-based.  The identical thing has occurred in the United States.  The safest borrowers borrow from the largest lenders, and the smaller, weaker borrowers go to the smaller, weaker lenders.  In addition, these weaker lenders are regionally based; therefore, loans made by these lenders is more concentrated than their larger competitors.  Continuing economics malaise outside Seoul continues to pressure the underlying projects, and the lenders to these projects.  Who are these lenders?  Savings banks.
Conclusions...Is Korea the Next Spain?  No, but...
The savings banks' asset size is relatively small in Korea.  Korea's financial services industry, as in most other developed economies, is dominated by the largest institutions.  However, the rising cost of living, when coupled with declining real estate values, is a dangerous combination.  If the savings banks' difficulties threaten overall consumer confidence in Korea, then that would represent a major problem.  As stated here, the Bank of Korea's job has been difficult, and will remain so.  A brief summary of some of the challenges facing the Bank of Korea has been posted here.  The latest difficulties at the savings banks is another important factor that must be taken into account.  There has been criticism of the Bank of Korea's most recent decision to keep interest rates steady.  In addition, the Bank of Korea has been criticized as being tied too directly to the Lee administration.  That is a gross oversimplification of the situation.
Before anyone believes that it is that simple, he/she should consider the Spanish example, where the banking system is in peril, and is part of the cause of the Spanish economic malaise.  Real estate problems led to banking sector problems in Spain.  Of course, South Korea's economy is more diverse than Spain's where real estate and tourism dominate.  Nevertheless, when real estate prices affect banks, then the analogy deserves thought.  Add rising energy prices and increasing overall inflation, and it isn't obvious at all that the Bank of Korea has done anything wrong. 


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