Banking And Non-Performing Asset Management

1. Prudential Standards
Although a foreign bank’s operating presence in Korea is in the form of a branch and
not a subsidiary, Korean regulations require branches to be separately capitalized. This
in turn impacts other regulations that are based on local branch capital, thereby
constraining foreign bank activities. For example, credit limits to companies/groups are
based on branch capital, as are open foreign exchange positions. AMCHAM
acknowledges that Korean regulators have recently modified their regulations to allow
for net borrowings from head offices to be included as Class B capital. Although this is
a welcomed step, Seoul cannot easily develop into a global or regional financial center
without further liberalization of what constitutes capital in a branch of a foreign
financial institution.

Recommendations
• AMCHAM encourages the Korean government to continue liberalizing all
banking regulations in Korea;
• Allow branches to use head office capital for regulatory purposes.

2. Credit Allocation
The Korean government has historically played an active role in allocating credit,
initially through domestic bank policy loans but also through portfolio restrictions that
apply to all banks operating in Korea. Foreign banks are held to strict monthly ratios
for small and medium sized companies. These ratios severely constrain operations,
resulting in an inefficient allocation and pricing of credit services.

Recommendation
• Eliminate portfolio limits for all banks.

3. Local Currency Funding

Foreign banks have been able to increase capital with relative ease over the past several
years (although thin ‘capitalization’ rules are still a constraint) and negotiable CD limits
have also been increased dramatically. The won inter-bank market is still dominated by
Korean banks and is an unreliable and inflexible source of funding by foreign banks,
particularly during periods of tight market liquidity. Furthermore, the inter-bank market
does not facilitate borrowings for greater periods of time other than on an overnight
basis. The government has revised regulations to allow commercial funding swaps and
has offered to increase central bank funding swaps.

Recommendations
• Establish policies to improve foreign bank access to the won inter-bank market;
• Establish policies to develop the inter-bank beyond an overnight market into
one that offers a variety of very short-term maturity instruments (i.e., 1 month, 3
month, 6 month funding instruments);
• Revise central bank swap pricing from a fixed return to cost basis.

4. Debt Collection Agency

Effective, privately managed, third party, non-banking related loan servicing and debt
collection agencies are needed in order to provide lenders and investors in Non-
Performing Loans (NPLs) with quality, professional NPL restructuring, collection and
resolution services. Currently Debt Collection Licenses are not available to qualified
restructuring, loan service and asset management companies which are not owned by a
financial institution.

The law was changed in April 2000 to allow non-bank related companies to manage and
collect loans under the Asset-Backed Securities (ABS) Law through the SPAMCO
(Special Asset Management Companies) qualifications process; however, this ABS
SPAMCO process is suited only for larger volume transactions. For small pools of non-
performing loans, the ABS SPAMCO requirements are not cost effective.

Recommendation
• Assist in the development of professional, third party, qualified private, non-
banking related loan-servicing and debt collection companies. These companies
would be in addition to those qualifying under the ABS SPAMCO qualification.
This change would provide buyers of non-performing debt in the secondary
market a non-bank related, qualified loan servicing and debt collection facility,
thus strengthening the prices in the secondary market for NPLs.

5. Transparency of Local Banking Regulations

Korean regulators are moving to address transparency problems but foreign banks
continue to be hampered by ambiguous and sometimes outdated regulations subject to
various interpretations by different regulatory authorities. The efforts of the Financial
Supervisory Service (FSS) to improve its communications to foreign banks have been
considerable. Unfortunately, other Korean agencies whose policies can affect the
foreign banks’ operations have not communicated their interpretations as effectively as
the FSS.

Recommendations
• Eliminate unnecessary banking regulations;
• Communicate the results of any further regulatory interpretation to all Korean
resident banks.

6. Accounting Standards
Significant progress has been made during the past year in the application of accounting
principles for the banking industry. This has been necessary in order to achieve the
successful restructuring taking place in the banking industry. As a result of Korea’s
addressing many of the transparency issues that have existed, opportunities to attract
capital have been enhanced.

To complete this process, and to provide a solid framework for the industry as it moves
forward, full adherence to international accounting principles is important. This is
particularly true for areas such as asset valuation, the criteria used for determining loan
loss reserves and the treatment of foreign exchange gains and losses. This is critical to
the process of improving the credibility of the banks’ financial statements, and in
attracting the necessary capital to properly strengthen the industry.

It is recognized that there are instances where the Korean government might find it
appropriate to deviate from international accounting principles for regulatory purposes.
However, these decisions should not affect the annual financial statements prepared for
the banks’ shareholders, which should fully comply with international accounting
principles.

Recommendation
• Complete the revision of Korean Generally Accepted Accounting Practices
(GAAPs) to improve the consistency and accuracy in financial reporting.
Strictly follow the standards once set and enforce discipline when rules are
violated.
7. Valuation of Non-Performing Loans
Although Korea has taken many important steps to lower the level of non-performing
loans on the books of its financial institutions, more could be done to facilitate the
process. One impediment to the selling of Non-Performing Loans (NPLs) has been the
difference between what a third party is willing to pay for the asset and the value that
the bank is carrying for the assets. Many banks are reluctant to sell assets because of the
accounting loss the sale would create. This reluctance to sell NPLs appears to be
slowing the process of improving the health of financial institutions.

Recommendation
• Create an environment whereby financial institutions are required to write down
non-performing loans to the lower of the market value or as set out by the
government’s asset classification standards.

8. Revision of the Credit Restructure Promotion Law (CRPL)

The Credit Restructure Promotion Law was passed and became effective on September
14, 2001. Although the intent of the law was to provide for increased transparency and
promotion in the corporate restructuring process in Korea, there are concerns that
without revision and clarification, the CRPL will cause inequities and be less effective.
Without revision of the CRPL, all parties involved in the Korean NPL market will be
negatively impacted, including Korean Banks, due to the uncertainties of this new law.

Recommendation
The definition of Financial Institutions, or those bound by the law, should be expanded
to include:
• Holders of Corporate Debt (including bond holders);
• Holders of Trade Debt

The valuation and buyout of the opposing creditors must include a fair, consistent, and
timely valuation process, as well as a timely and fair procedure for temporarily staying
an opposing creditor’s rights and the payment and method of the agreed buy-out price.

Incentives should be provided to those participants that want to advance new money
with the consent of those not able to advance new money. This will eliminate the
situation whereby a financial institution is forced out of the plan due solely to the
requirement to advance new money.
9. Awarded Foreclosure Process and Groundless Appeals
Currently the foreclosure appeal process allows any party, whether they are a party at
interest or not, to appeal an auction award with minimal support for the basis of the
appeal. Typically, the reasons are groundless and the appeal process is used to delay
and subvert the legal process. There is no cost or consequence associated with
groundless appeals. This process effects not only the NPL buyers in the Korean market,
but it also covers all lenders including Korean Lending institutions. Among the NPL
purchasers in the Korean market, there is in excess of 100 billion KRW under appeal.
There is no cost associated with filing an appeal and multiple appeals can be filed and
refiled, regardless of the ultimate court’s dismissal of an appeal.

Recommendation
• Require that the appellant post an appeal bond equal to no less than 10% of the
amount at issue, plus all other costs associated with the appeal process, and only
allow an appeal to be filed within a specific time frame from the date of an
award. If the appeal is denied, then the appeal bond is forfeited. Any further
appeals would require successively greater appeal bonds. Further, the court
should allow the lender to provide written argument to the court supporting
dismissal of groundless appeals.