When the draft bill of the 'Law on Financial Management Industry and Capital Markets'(hereafter, the Capital Markets Consolidation Law) was released on Feb 20th, the media hailed it as if the new law will greatly improve the competitiveness of Korea's financial industry. Probably the financial industry itself seemed to construe the situation in the same nonchalant way as the media did. For it hasn't shown any reactions to the launching of the negotiation on the Korea-US Free Trade Agreement since its first disclosure, contrary to both the farmers' and the film workers' violent resistances to it.

If so, will Korea's financial industry really become as competitive as the US financial industry, when the draft bill passes the National Assembly and takes effect as law in 2008, as the Ministry of Finance and Economy expects?

But something makes it look too lax for the Ministry of Finance and Economy to announce, at this moment, the draft bill on the capital markets consolidation scheduled to become law in 2008, given that the negotiation for the Korea-US FTA has already commenced and is expected to take effect, at the latest, by mid next year. To see what makes such attitudes of the ministry look so lax, it is necessary to look at a little bit of the financial histories of the US and Britain.

Korea, 20 years behind

As is well known, it was 1980 that the US started liberalizing its financial industry in earnest, by enacting the Depository Institutions Deregulation and Monetary Control Act which was aimed at liberalizing depository institutions, and reinforcing the monetary control on them accordingly. After the liberalization, the US had gone through the pains such as large-scale simultaneous bankruptcies of the savings and loan associations, due to the market flaws that had been accumulated during the regulatory period since the 1930's. But it was through such trial and errors that the US financial industry has reached where it is now, the world no. 1 position.

Britain was the nation that was most shocked by the 1980 financial reform of the US. At the time, Britain prided herself on having the foremost advanced financial industry in the world. Though they had been aware that the US was trying to attract the world financial center from London to New York, they were not worried about that. But when the US carried out the grand-scale financial reform in 1980, Britain lost its composure.

In 1986 Britain, conscious of the importance of having an advanced system to keep moving ahead of others, at last carried out what was called as the "big bang" reform, which was a financial reform more comprehensive and more advanced than the 1980 one of the US. The major characteristic of the "big bang" was the complete dissolution of the separation between commercial banking and investment banking - a measure that even the US has not been able to implement in its 1980 reform.

Nowadays, almost all the experts say in unison that the US financial industry is more advanced than the British one. But at the time, Britain took so immense efforts as to undertake such reforms as the "big bang" in order to keep the upper hand over the US. We need to learn from such ardent determination of the British authority.

The FTA negotiation with the US and the resistances from both the film workers and the farmers to it are great challenges to Korea. However, the financial sector poses much greater challenges than the film industry and the agriculture do, from the viewpoint of the bright future of Korean economy.

The reason is as follows. First of all, Korea's financial industry is far behind that of the US; we have long been aware of it without knowing exactly how far we were behind. Now the time lag between the US and Korea has become clear with the enactment of the Capital Markets Consolidation Law around the corner. That is, the financial system that we are going to have in 2008 is similar in structure with the US financial system before the 1980 financial reform, and therefore it becomes certain that there is at least a 20 year gap between the financial industries of the two economies.

A need for a strategy to get ahead of others

To look at them more precise, the present Capital Markets Consolidation Law consolidates the areas of stock brokerage, trust fund management and others into what could be roughly called the investment banking area in the US. But in the US, such an integrated structure of financial system had long been in place before the 1980 financial reform. The highpoint of the 1980 Deregulation Act is that it legalized even those illegal incursions (thus customarily liberalized) which commercial, investment, and saving banks had made so far into each other's business areas.
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Again, at the time of the 1986 "big bang" reform, the British financial markets were in more advanced stage than those of the US. But to recover the delay in reform, Britain tried to introduce a more advanced system than that of the US. Despite such efforts, Britain failed to overcome the US in the end.

In view of these historical facts, the strategy of Korea, as a nation which is already far behind the US, needs to be more drastically different. In addition, in a situation that Korea's domestic market is being integrated with that of the US through an FTA, mere survival will be a formidable task for Korea's financial industry, let alone taking the lead. Under such circumstances, what would happen to our financial industry when regulations still hidden underneath the table of the Ministry of Finance and Economy are hindering the financial institutions from making efforts to improve themselves, and, if they ever did, those efforts would bear no fruit, because of those regulations?

It would be all right if a bright future of Korea's economy can be guaranteed through a division of labor between Korea's just concentrating on manufacturing while the US on financial business. But there will be no such simple solutions in the world. It would be fair to say that the more sectors of industry remain alive in competition with the US, the more promising future of our economy we would get. And among the industries we wish to survive for our bright economic future, the financial industry has to be placed at the top. That is because the financial industry has to be our future industry as it is a knowledge-based industry, and it is the industry that will help other industries go through smooth restructuring processes. Also, if Korea's financial industry manages to become competitive enough under the FTA regime with the US, it will be a leading force in the Chinese markets as well as in the Asian market as a whole, as the British one is doing in Europe.

Unfortunately, judging by the present regulatory framework, the 1980 level of the US financial system is as far as the Korean financial one is allowed to climb up when it reaches year 2008. This pitiful situation is created by the Ministry of Finance and Economy that has been avoiding liberalization because of their strong wish to maintain their turf.

Fundamental changes, imperative

If the Ministry of Finance and Economy has any intention to improve the present situation at all, it should adopt the British style reform of "big bang", system-wise at least, which would give our financial system room for manoeuvre to move ahead of the US. Even a "big bang" type of reform may not be enough. We need to do more to catch up with the US. That is, we need to abolish the principle that separates finance from industry - a step that even the US has not yet been able to take.

It takes much more capital for the financial sector to gain competitive power than for other industries to obtain a comparable competitive power. And we need to redress the imbalance between non-financial sectors whose abundant cash reserves have failed to find profitable investment opportunities, and the financial sector that presently lacks much needed large-scale capital. The present abundance of capital in the industrial sector, once properly used, will be a great help for the Korea's industries to go through restructuring so as to become viable enough in the Korea-US FTA environment.

Also, the government should stop pursuing to revise the Act on the Structural Improvement of the Financial Industry, in the direction of unnecessarily weakening the governance structure of corporations. In fact, the Improvement Act (and its revision bill to a greater extent) contains some undesirable clauses that bifurcate the industrial capital and the financial capital too excessively. In view of the convention that the advanced economies do not ban financial institutions from owning the shares of non-financial corporations, revision of the Improvement Act in this direction would only drag the inefficient system into a far worse one.

But much more than that would be needed to make our financial industry competitive enough. Especially in these globalized environment, in order to manage the financial institutions such as banks and insurance companies successfully, the managers need to have penetrating insight to be able to read the vicissitudes of industries in the midst of whimsical international climates and to evaluate the prospects of various industries and enterprises, making loans to the promising ones.

However, the CEOs of Korean banks that are located in the center of our financial industry are transfixed only by defending "native" banks and companies. Everyone knows that we do not live in the Chosun Dynasty. We would never be able to compete with the US financial institutions unless we get rid of such an anachronistic insular mind-set. We need to let the skills and the spirits that have succeeded in managing the global companies come into the Korean financial sector - even for the sake of overthrowing such anachronism. For this to happen, at least two regulations, i.e., the Ceiling on Total Amount of Share-holdings in Other Companies and the Act on Structural Improvement of the Financial Industry need to be scrapped, in addition to abolishing the separation of finance from industry.

In particular, the Ceiling on Total Amount of Share-holdings in Other Companies should be abolished immediately to broaden the ways and means for the conglomerates to defend themselves from hostile M&A. Whether the conglomerates would adopt the holding company systems to control the companies in each group or to maintain the traditional corporate governance should be left as a matter to be decided by each of the conglomerates themselves.

Need to acknowledge a critical moment

Viewing from the standpoint that those regulations basically stem from Korea's peculiar anti-enterprise sentiments, transforming such mentality would be a more urgent matter. But we do not have enough time to change those sentiments. For the Korea-US FTA will have come into effect in around one year and the global financial environment will raise drastically the level of pressure on to Korea's financial industry. But the ban on industrial capital to flow into financial institutions and the capping of total share-holdings on companies by the conglomerates can be lifted immediately, by simply revising the relevant laws. With such measures, we can provide the right structural environment for entrepreneurs to act most creatively, hopefully for the best results.

If the Ministry of Finance and Economy truly wants that Korea's financial industry survive in the global competitive environment newly created within the framework of the Korea-US FTA, and that Korea's economy as a whole prosper for a long time, they have to give up categorically their age-old privileges. They must let the so-called 'financial supermarket' be established freely by abolishing all the border restrictions, all at once, between banks, stock brokerage firms (or investment banks) and insurance companies, as early as possible.

Kim Han-eung (Co-Director, Free Citizens' Alliance of Korea, hane9kim@chol.com)

 

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