AN IN-DEPTH LOOK AT THE KOREAN ECONOMY AND

POLICY RESPONSES TO THE CURRENT CRISIS

December, 2009

Financial Services Commission

 Table of Contents

1. Current Status of the Korean Economy and Financial Markets

2. Risks and Challenges Raised during the Crisis

3. Policy Responses

4. Lessons Learned
1. Current Status of the Korean Economy
and Financial Markets
 Real Economy

Real GDP Growth Industry Outputs

10 30 (YoY growth, %)
(YoY growth, %)
20
5
10

0 0
-10
-5 -20
-30
-10
-40
-15 -50
Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09
Hong Kong Singapore Taiwan Korea Hong Kong Singapore Taiwan Korea

Exports Retail Sales

40 25
(YoY growth, %) (YoY growth, %)
30 20
20 15
10
10
0
5
-10
0
-20
-5
-30
-10
-40
-15
-50
Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09
Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09
Hong Kong Singapore Taiwan Korea Hong Kong Singapore Taiwan Korea
4
 Financial Market

Comparison of Stock Price Movements Exchange Rate Changes(Local currency/USD)

120
(Jan.1, 2008=100) 180
(Jan.1, 2008=100)
100 160
140
80 120

60 100
80
40 60
40
20
20
0 0
Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09
US Japan China Korea Japan Euro UK Korea

CDS premium(5yr) Comparison of Money Market Rates

800 7
(bp) (%)
CD(91days, Kor)
700 6
Target Rate(Kor)
600 Malaysia
5 LIBOR(3M)
China
500
Thailand 4
400 Korea
3
300
2
200

100 1

0 0
Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 5
2. Risks and Challenges Raised during the Crisis
Risks and Challenges

Risk Factors Effects

High current external debt to FX reserves ratio

#1 Lack of FX liquidity
Reduction of FX reserves
Increased pressure on FX liquidity
for Korean banks with large amount of short-term external debts

#2 Rapid economic recession
Global economic recession
Decrease in exports & slowdown
in domestic consumption
Negative economic growth

Fall in incomes & real estate prices
Possible deterioration of

#3 Possible deterioration of households
private sector
Economic recession, credit crunch
Possible deterioration of
corporate sector

Possible deterioration of
Non-performing household and corporate loans, loss of principal

#4 banks’ soundness investment
Deterioration of capital soundness

High loan-to-deposit ratio, short term funding
Funding
mismatch
Liquidity problem

7
3. Policy Responses
Policy Framework

Initial Response Medium-term Responses: Key Framework

after the Lehman shock
#2
● Policy rate cut: 5.25% → Stimulus
Fiscal 2.0% Package
#1
FX Market Stabilization ● Won liquidity provision: 23.3 tn won
● Total Stimulus package: 7.4% of GDP (4.3% in 2009)
#3
Corporate Sector Liquidity Provision
● Extension of SME loans and guarantees due 2009
• Payment guarantee of ● Creation of Bond Market Stabilization Fund (10 tn won)
foreign currency #4
borrowings by domestic Enhancing Banks’ Soundness
banks: $100 bn Deepening ● Launching of Bank Recapitalization Fund: 20 tn won
Economic ● Purchase of banks’ bad assets through Restructuring Fund by
• Currency swap lines with Recession KAMCO (40 tn won)
U.S., Japan, and China: ● Financial Stabilization Fund
$30 bn each /
#5
$90 bn in total Corporate Restructuring
● Creditor financial institution-led restructuring
• $55 bn foreign liquidity
● Market-based restructuring
provision by the BOK and
the government #6 Social Safety Net
● Financial support through Miso Credit Foundation
● Credit recovery support for low-income households through
debt restructuring and refinancing at lower rates

9
 1 FX Market Stabilization
Currency Swap Lines : $90 bn Foreign Liquidity Provision : $55 bn

Government & BOK

Set up $30 bn currency swap line with the U.S.
(Oct. 2008) and expanded existing currency swap
lines with Japan an China to $30 bn each (Dec.
2008) Trade Finance: Market liquidity

Decisive role in resolving concerns over Korean $21 bn provision: $34 bn
financial institutions’ FX liquidity conditions

Banks

US Payment Guarantee

$30 bn
Foreign Domestic
Bank Bank
Korea
$30 bn $30 bn

Government
Japan China

Payment guarantee of foreign currency

borrowings: $100 bn

10
 2 Fiscal Stimulus Package

Tax Cuts and Expansionary Spending to Boost Domestic Economy

Tax Cuts Expansionary Spending Total (% of GDP)

Total KRW 33.4 tn KRW 33.7 tn KRW 67.1 tn (7.4%)

2009 KRW 9.8 tn KRW 29.1 tn KRW 38.9 tn (4.3%)

Sound Fiscal Position Debt Level Lower Than G-20 Peers(2009e)

4 3.5 250 (%)

3.1 217.2
3
200
2
1.1 1.0 1.2 G-20 Average: 75.7%
0.6 150
1 0.4 0.4

0 100 87
74.9
-1 62.7
Government surplus (% of GDP) 50 35.6
-2
-2.1
-3 0
2001 2002 2003 2004 2005 2006 2007 2008 2009 Korea US Japan UK France 11
 3 Corporate Sector Liquidity Provision

Extension of SME loans and guarantees Policy Banks & National Guarantors(trn, won)
68
54
KDB 32

Maturity extension of guarantees provided by KDB 27
public guarantors till end-2009 IBK 27 IBK 36

Maturity extension for SME loans falling due within
64.3
2009 46.3
Kodit 36.3

Review standards and limits eased for new loan Kodit 28.7
guarantees and required process expedited Kibo 16.3
Kibo 12.2
Etc 5.4 Etc 11.7
2008 2009

Creation of Bond Market Stabilization Fund (10trn. won)

Kodit, Kibo
Guarantees maturing
KDB Banks
within 2009
Insurance Securities
Extension of Companies Companies
2 tn 6 tn
maturity for 0.5 tn
1.5 tn
SME loans
and Fund (10 trillion won)
guarantees
Loans maturing
within 2009
Banks
Corporate SME ABS issued by
PF-ABCP credit-specialized
bond P-CBO financial institutions

12
4 Enhancing Banks’ Soundness

Asset Soundness Improvement Recapitalization

Corporate 20 tn won Bank Financial Stabilization

KAMCO
Restructuring Fund Recapitalization Fund Fund

-Purchase - Bank-specific credit Banks’

of non- - Purchase of NPLs self- - MOUs to boost
- Purchase of assets limit, withdrawal when
performing necessary recapitali- SMEs and real
of companies under
PF loans of - No government zation sector support
restructuring
banks and - 40 tn won intervention in banks’ (18 tn - Fund size to be
savings -Operation till 2014 shareholders’ right won) decided
banks and management right

Recapitalization Recapitalization
Purchase of Purchase of
troubled assets troubled assets

Non-banks Non-banks Normal

비으
Banks

(Potential) Insolvency

KDIC
-Support through capital injection or
contribution in kind
- Selling assets or merger with others

13
4-1 Bank Recapitalization Fund

Structure of Bank Recapitalization Fund

Objective

Institutional & Public

Bank of Korea
Investors

To improve capital
adequacy without direct (10 tn won loan)
injection of government
funds Purchase ABS
Korea Development
(8 tn won)
Bank

To encourage banks to
(2 tn won loan)
actively support the real
economy by increasing
their loss absorption
capacity Recapitalization Fund (20 tn won)

To induce banks’ active Purchase subordinated Purchase hybrid bonds (8 tn won) &
participation in corporate bonds (10 tn won) preferred stocks (2 tn won)
restructuring efforts (e.g.
new funding support to
workout firms)
Banks’ Subordinated Banks’ Hybrid Bonds & Preferred
Bonds (10 tn won) Stocks (10 tn won)

14
5 Corporate Restructuring : Framework

Principles Methods

#1 A Normal: Support

B Temporary liquidity shortage: Support

Creditor financial institution-led
restructuring C Signs of insolvency but viable: Workout
Sound
Corp. D Non-viable: Liquidation

#2
A
Market-based restructuring
- Encouraging private capital participation NO
B
Weak Signs of
Corp. Insolvency?
#3 YES
Corporate restructuring YES C
support system
- Setting up a restructuring fund & Viable ?
tax incentives NO D

15
5 Corporate Restructuring : Implementation

Restructuring Targets Progress

Prioritize target industries 46 out of 277 construction, shipbuilding and

Industry-based according to the risk of shipping companies have been selected as
restructuring default restructuring targets

9 out of 45 main debtor groups have signed

Large Business Groups
MOU on capital structure improvement

Size-based Individual Large Restructuring is underway for selected 33

restructuring Corporations large corporations

113 SMEs have been chosen as the targets

SMEs for the first round of restructuring, and the
second round evaluation is underway

16
 6 Social Safety Net

Financial Support through Miso Credit Foundation Expansion of Credit Restoration Fund Programs

Contribution
from dormant Miso Credit Donation
accounts from
Foundation Defaults of Financial High Interest Rate
from banks individuals
(formerly, Micro-credit and Obligation Payers
and
insurance Foundation) businesses

200~300 Miso Credit

Foundation Branches
(independently incorporated)
Debt Refinancing at
Restructuring lower rates
Low-rate loan for
business startups and
traditional market merchants No. of
Beneficiaries Eligible Loans
(10 thousand) (trillion won)

Plan to raise and support 2 tn won over 10 years 72 7.3

* More than 13 times the amount raised over the past

decade (148 bn won, 2000~2009)
46 2.2

Expansion of the national network (No. of MCIs: 30 
200~300)
2008 2009 2008 2009

Engagement of voluntary workers (e.g. retired financiers
, youths)

17
4. Lessons Learned
Lessons from the Crisis : Past and Present
Main Causes of the
Main Causes of the Current Global Crisis
1997 Asian Financial Crisis

Global investors’ doubt over the Korean

government’s responses based on their past

Excessive debts & lack of Stigma experience in 1997
transparency in corporate sector Effect

Circumstances in Korea was thought to be

Prevalent moral hazard caused worse than the actual situation
by distorted lending practices of
financial institutions & failure to
adapt to rapid financial
Non-
KRW weakened rapidly as financial institutions
liberalization
Possession moved to USD

Lack of timely response (e.g., of Reserve
Korea suffered more than it deserved as a
through restructuring) to the Currency country without reserve currency
spread of risks in the
international financial market

Inadequate prudential
Export-
It was widely believed that export-oriented
regulations
oriented Korea would be hurt more as the global
Economy economic recession deepens

19
Comparison with Asian Financial Crisis

Korea’s financial condition has improved vastly over the past ten years and the country is well-
prepared to manage the current crisis

Asian Financial Crisis

Current
(late 1997)

Causes
Internal factors such as External factors
corporate bankruptcy

Foreign Currency Reserves US$ 8.9bn US$ 239.7bn 1

ST External Debt / FX Reserves 717% 79%1

Foreign Exchange
Liquid External Debt / FX Reserves 973% 95%1
Total External Debt / FX Reserves 1,957% 177%1

Bank NPL Ratio 6.0% 1.48% 2

Banks
BIS Ratio 7.0% 13.74% 2

Corporate Debt Ratio 424.6% 108.8% 3

Corporates
Corporate Interest Coverage Ratio 115.0% 361.7% 3
1 as of September 2008
2 as of September 2009
3 as of June of 2009
20
Self-Evaluation
Prompt and Honest Response

Immediately after identifying signs of a crisis, the Korean government promptly prepared
countermeasures in coordination among relevant ministries.

With frank assessment of certain weaknesses, the government provided accurate and detailed
information to investors to address misunderstandings and restore market confidence.

Management of Financial Sector Soundness

Household and corporate loan delinquency rates managed at stable 1 percent-level
Little
possibility of massive banking sector defaults

This is largely attributable to aggressive monetary and financial policies, including tight LTV/DTI
regulations.

Past Restructuring Experience

With an institutional framework (e.g., KAMCO and Korea Deposit Insurance Corporation) and a legal
framework (e.g., Consolidated Insolvency Act and Corporate Restructuring Promotion Act)
established since the 1997 financial crisis to deal with restructuring and resolution of NPLs, Korea
responded to the crisis in a timely manner.

Sound Real Sector/Fiscal Fundamentals

Since the 1997 financial crisis, Korean companies have continued to increase capital and lower
debts.

The government has maintained a sound fiscal position to be able to provide large-scale stimulus
package in time.

Macro-Prudential Supervisory System

Need to improve macro-prudential supervisory system to prevent herd behavior among market
participants.

21
This material has been produced by the Financial Services Commission of Korea(the “FSC”) for
information purposes only and does not constitute an offer to sell or a solicitation to buy any
security or other financial instrument. The information contained in this document has not been
independently verified and neither approval nor guarantee is given that it is accurate or complete.
The opinions, forecasts, assumption, estimates and derived valuations contained in this material
should be considered in the context of the circumstances prevailing at the time indicated and are
subject to change at any time without prior notice. Neither the FSC nor other persons shall be
liable for any direct, indirect, special, incidental, consequential, punitive or exemplary damages,
including lost profits arising in any way from the information contained in this material. This
material is for the use of intended recipients only and the contents may not be reproduced,
redistributed, or copied in whole or in part for any purpose without FSC’s prior express consent.
International Cooperation Team
Financial Policy Bureau
Financial Services Commission
Tel 82-2-2156-9661~4
Fax 82-2-2156-9669
fsc_intl@korea.kr
http://www.fsc.go.kr