THE KOREAN BANKING system should be a lot healthier than it is. Since 1998, following the regional financial crisis, the country's banks have been in constant merger mode. Twenty-seven banks have been reduced to just 11 under government pressure for them to strengthen capital adequacy ratios and improve lending practices.
Despite these efforts, though, Korea's banks have been slow to learn lessons about lending but quick to find new ways to lose money.
It's not entirely their own fault: the government is unable to stop tinkering with a sector that most developed countries have long concluded operates most effectively independently of political interference. After the chaebol lending debacle, which sprang from massive overlending by banks to Korea's family-controlled and corruption-tainted conglomerates, Korean banks entered into a government-inspired consumer lending frenzy. In 2000 and 2001, an average of 82,650 new credit cards were issued every day.
It was an ill-advised attempt to stimulate domestic demand that resulted in credit card delinquency ratios hitting almost 50% at their peak. A disaster in the making, obvious to everyone save the banks and the government themselves, it left almost 4 million Koreans credit blacklisted and effectively out of the consumer economy.
After enduring a second bad debt crisis so soon after the first, the banks again professed that they had learnt powerful lessons that would ensure such mistakes were not repeated.
"After the financial crisis, we developed a lot of internal systems," says Yang Shin Keun, deputy president and head of treasury division at Shinhan Bank, "especially in credit risk management."
Most of Korea's banks make the same claim. Now the latest test of the bank's purported stricter credit controls is about to arrive.
After the credit card market blew up and the government stepped in to curb new lending to the consumer sector, banks started to lend aggressively to small and medium-size enterprises in an attempt to bolster assets and profits.
Such was the shift into this sector that combined SME loan growth from 2000 onwards reached 26% year on year by March 2003, according to Deutsche Bank, before slowing to a still rapid 17% by the first quarter of 2004.
Deutsche estimates that at the end of 2003, loans to SMEs accounted for some 45% of total bank lending in Korea. This compares with loans to large corporations, excluding banks' holdings of corporate bonds, of just 6% of total loans.
Renewed recklessness
Analysts are increasingly concerned that the banks might have taken the same reckless approach to lending as before and are warning of serious risks to asset quality.
"With 45% of bank lending allocated to SMEs," write Juliana Lee and Michael Spencer of Deutsche Bank in a report entitled SME Finances in Korea, "this sector presents a more significant source of systemic risk than the credit card industry."
With the fast loan growth of the past few years has come an increase in loan delinquencies, meaning broadly any loan that is past due whether on interest or principal. Standing at approximately 2.1% at the end of December, delinquencies might appear relatively low but, as Deutsche Bank notes, the figures are higher than rates for large corporations and have been rising for the past few years. Deutsche now believes that, as with credit cards, the low loan delinquencies might conceal a larger problem.
Jim Antos, banking analyst with Bear Stearns in Hong Kong, harbours the same suspicions. Antos compared the ratio of total SME loans graded precautionary and below (meaning all non-normal loans) with those loans more than one month past due across the three largest banks: Woori, Hana and Kookmin.
"In our view," writes Antos, "for all three banks, we find that delinquency rates give an over-optimistic view of the quality of SME loans. SME loans graded precautionary or worse average roughly five times higher than accounts that are over one month past due."
Andrew Reynolds, an analyst at CLSA in Korea, is also concerned that much lurks behind the strong growth in SME loans that is not immediately apparent. "When consumer loans rolled over," he says, "SME loans grew for over a year so you have to think that banks were making loans that they shouldn't have been."
His suspicions are based on the banks' poor track record in managing strong loan growth without impairing credit quality.
Some banks defend themselves, sticking to the assertion that all has changed since the last loan crisis in mid 2002. "The market is concerned about SME loans," admits KS Choi, general manager and head of investor relations at key lender Kookmin Bank, "because they believe that in Korea, anything in banking with fast growth collapses. But it's not true. Fast growth does not necessarily equal failure. Fast credit card growth should have been fine if you would have stuck to your credit disciplines: they [the credit card companies and banks] didn't do that. The SME situation is a totally different story and we do go through the full credit analysis process. It's a totally different ball game."
Perhaps, but as Shinhan's Yang explains, the devil is in the detail. "Everyone's worrying about SME," he says, "but it depends on the portfolio of each bank."
Analysts agree with him. The SME sector in Korea is itself large and diverse, with companies undertaking a variety of activities. Broadly, the concerns of banks and the market alike lie with the domestic-focused companies, mainly retail and services that also tend to be smaller than SMEs operating in the export or export-related sectors.
CLSA's Reynolds explains: "You have to draw a distinction between SMEs," he says. "The larger ones, about 30% of the total, are exporters or export suppliers. Korean exports are very strong now and so they're pretty healthy. It's among the sole proprietors and the lower-end SMEs where the problems lie."
Accounting for some 70% of total companies in the sector, the smaller, consumer-focused SMEs, sometimes referred to as Soho (small office, home office), are suffering from the lacklustre domestic economy. Consumer spending has been badly affected by the credit card crisis as well as government measures introduced to curb household lending.