The World Cup of Banking Reform

ROBERT ZIELINSKIWhen it comes to national rivalries, few are as intense as that between South Korea and Japan. These two countries tend to slug it out in whatever arena they can find: cars, semiconductors, steel. If one country makes the product, so does the other. The competition is so fierce that the hosting of the World Cup in 2002 had to be split between them in the interests of maintaining global peace. In many aspects of this rivalry, Japan holds the upper hand. But when it comes to the critical issue of sorting out the troubled banking industry, Korea is winning in every way.Both nations face a severe banking crisis. That's not surprising, since Korea has modeled its banking industry, and indeed its economy, on those of Japan. Banks in both countries have to cope with similar bureaucratic managers, government red tape and big borrowers whose main objective is simply to get bigger. But there is one important difference: Korea's financial crisis is acute, while Japan's is chronic. Bad loans in Korea are up sharply, and the government lacks the financial resources to bail out the banking sector on its own. Korea needs to adopt drastic measures and, as with many things the country sets its mind to, it's doing so with a vengeance. Let's take a look at how this World Cup of bank restructuring is progressing.In resolving any banking crisis, the first step is usually to cut operating costs by firing staff. In Korea, 21% of all bankers lost their jobs in the first six months of 1998. By contrast, the number of Japanese bankers has fallen by only 6% in the past six years, and this was achieved largely through retirements. Score: Korea 1, Japan 0.Turning around a bank generally requires a new management team, unburdened by responsibility for past mistakes. In Korea, more than half of bank managers have been sacked in the past year. In Japan, practically all of the old crowd are still around. The most severe punishment ever discussed for a Japanese banker is to (gasp!) have him apologize for making bad loans. Score: Korea 2, Japan 0.Assessing the size of the bad-loan problem is critical in dealing with it. Korea has aggressively pushed its banks to disclose their problem loans, even those granted to borrowers who are still making payments but have a lot of debt outstanding. Japan is considering introducing a watered-down version of this some time this year. Score: Korea 3, Japan 0.PAGE 1|Banks need to get bad assets off their books. Korean banks have sold more than $30 billion of their non-performing loans to a government entity; that's 10% of all bank lending. These loans and their collateral are now being auctioned off to investors. Japanese banks are largely keeping problem loans on their books in the hopes that a real estate bubble will magically reappear. Score: Korea 4, Japan 0.Banks that are bust must be dealt with quickly. At the beginning of 1998, Korea had 26 commercial banks. Since then, four have been nationalized, two were strongly advised to merge and five were forcibly acquired. By the end of this year, Korea may have only eight commercial banks. In Japan, the number has fallen only slightly, from 144 in 1991 to 139 today. The government spent months agonizing over whether to nationalize the clearly insolvent Long-Term Credit Bank of Japan. Score: Korea 5, Japan 0.Foreign banks need to be let into closed banking markets, which desperately need innovation and competition. The Korean government just announced the sale of one of its nationalized banks to a U.S. investment fund, marking the first time in Asia that a leading bank has been sold to foreigners. Another nationalized bank is up for grabs. In Japan, not one bank has been allowed to fall into foreign hands. Score: Korea 6, Japan 0.Both countries need to restructure their industrial sectors, whose poor profitability and bad investment decisions have compounded the banks' problems. In Korea, the government is now going after the chaebol, the big industrial groups. It has cut them off from outside borrowing to force them to sell off subsidiaries, streamline operations and focus on core businesses. In Japan, the unwieldy keiretsu are vowing to help each other out in order to avoid such hard decisions. Some banks are even forgiving loans rather than forcing insolvent borrowers to go under. Score: Korea 7, Japan 0.The endgame to any such crisis is recapitalizing the banking industry. Korea has done a lot in a short period to make its banks attractive to domestic and foreign investors. That helps explain why Korean banks' share prices have more than doubled in recent months. Only a rejuvenated industry can raise the money it needs on its own. On this issue, however, Japan may actually score. Although its banks have not done much to restructure, Japan plans to give them $500 billion to recapitalize--the World Cup equivalent of bribing the officials. But such a Japanese victory means little--and is likely to be short-lived as the old problems reemerge. In this competition, I'd put my money on Korea.Robert Zielinski heads Asian financial institution equity research for Lehman Brothers in Tokyo|2