Korean bank regulation and supervision: crisis and reform (a critical evaluation with recommendations).

Abstract

This thesis presents a critical analysis and evaluation of the current Korean banking regulatory and supervisory system. The objective is to identif' continuing structural weaknesses of the Korean banking system and to suggest areas of regulatory and supervisory system reform. The focus of this analysis and evaluation is centred around the following three questions: (1) Who should be the regulator? (2) What substantive standards of supervision should be applied? and (3) Administratively, in what manner should these standarus be applied? Finally, the causes, responses, and implications for reform as to the recent Korean financial crisis are discussed. The Korean banking system has been characterised as a "governmental control system" for credit allocation. This system, with lax prudential regulation and supervision, creates inevitable problems for the banks. For example, Korean banks have been largely precluded from true market and commercially oriented practices and have been exposed to significant credit and other risks due to governmental policy directed lending and other non-commercially induced banking practices. The main theme of this thesis is that Korea's reformed and restructured regulatory and supervisory system should be structurally removed from undue governmental and political interference; that is, should be sufficiently divorced and protected from governmental economic policy objectives and, more generally, from objectives that are inconsistent with "safety and soundness" based banking regulatory and supervisory objectives and with market oriented practices. Balancing this structural independence and market orientation, a reformed and restructured system should provide a high degree of transparency and accountability. Reform should aim not only at establishing effective supervisory standards, but also at ensuring effective monitoring and enforcement. A first step to the reform is for the government to define and adhere to a primary policy objective of banking policy, i.e. "financial stability" through sound and effective Korean banking regulation and supervision. To achieve such financial stability, Korea will need to implement appropriate measures that can ensure that the banking system is "safe and sound", consistently with evolving international standards; that banks are free from undue governmental and political interference and control; and that the banking system operates within a competitive and commercially driven market environment. The financial crisis in 1997 has demonstrated many of the current weaknesses of the Korean financial system. The need for certainty of process, for a clear, realistic and transparent timetable for restructuring, and for an effective exit policy for troubled commercial banks, are some of the lessons to be learned from this crisis.