Capital Market Reform

Gov't to push the financial hub project

Deputy Prime Minister and Minister for Finance and Economy Kwon O-kyu says the subprime credit crisis will have only a limited impact on the domestic financial market. He also stresses the financial hub project is an important state policy which will surely move the financial industry and the national economy forward. DPM Kwon will lead a Korean delegation to the 2007 Annual Meetings of World Bank Group/IMF, to be held in Washington D.C. on Oct. 20-22. The following are excerpts from a written interview with Kwon:
Question: Will you tell us about the agenda items to be submitted during the upcoming IMF session?
Answer: Agenda items to be presented for the IMF session will include:
* Ways of resolving unstable factors in the international financial market like the subprime crisis and risk management
- liquidation of assets like CDO and enhancing the transparency of hedge funds
- strengthening the responsibility for inappropriate credit ratings and preventing possible moral decay
- balanced approaches are needed considering the positions of interested nations regarding regulatory measures to enhance the transparency of state-issued funds.
* Immediate agreement on a second quota increase is needed
- We will call for the immediate agreement on quota reform, which reflects each nation's economic status as a way toward securing representation in the IMF deliberation regime.
- We will also urge prompt action to rearrange the World Bank (WB) portion
* It is necessary to maintain the IMF's mid-term reform agenda even after the IMF chief retires.
- Strengthening of surveillance coupled with the preparation of a new income model.
* Advice on WB long-term strategy
- Call for focusing on areas where WB has strength
- Pursuit of WB in-house reforms through checks and balances
* Reconfirmation of our government's willingness to expand international assistance
- Will announce plan to set up a $30 million fund and share the experience of national development
- Will call for cooperation to help secure North Korea membership in the IMF and World Bank.
- On the occasion of the inter-Korean summit, we will also call for efforts to lay the foundation for North Korea's entry into international organizations and educate North Korean officials about the market economy system.
Q: Would you explain what the government's plans are to cope with the possible financial difficulties due to the subprime credit crisis in the United States?
A: The current subprime crisis was caused by the combined factors of a sluggish housing industry and a rise in interest rates for mortgage loans. There has been a flux in international liquidity, such as the reassessment of risks and leverage reduction in the global financial market.
But the Korean market is unlikely to be affected much by the crunch. The crisis began as an external factor, it did not originate inside the Korean economy. Korean financial institutes have very little exposure to subprime-related assets (about $850 million). The loss will likely be confined as most assets have high credit ratings.
Unlike during the 1997 financial crisis, the Korean banking industry has grown to be able to cope with possible difficulties. In particular, the Korean government has taken preemptive measures like strengthening debt to income (DTI) and loan to value ratio (LTV) to prevent the subprime crisis from spilling over into the domestic market.
Currently, the Korean government is operating a task force composed of officials from the central Bank of Korea and financial watchdog bodies. If abnormal symptoms are detected, we will take proper measures in advance. In the process, we will increase liquidity in the market once there is sign of credit strain.
Q: How has the subprime crisis been affecting the global financial market?
A: Subprime mortgage loans have continued to increase, boosted by a housing construction boom, which resulted in an easing of loan requirement due to excessive competition among the mortgage loan companies. Borrowers have been facing difficulties in paying their mortgages due to a rise in interest rates coupled with a drop in housing prices. From the end of last year, the subprime crisis deteriorated as seen in the increase in bankruptcies and foreclosures of houses.
An increasing number of mortgage companies have gone bankrupt and investors in mortgage-related stocks have also begun to feel the pain since June this year. Subprime mortgages account for 10 percent of the total mortgage market in the United States and only 1 percent of the entire financial market. So, it has little impact upon the overall financial market.
But a growing number of investors will likely opt for stable assets which will lead to a drop in stock prices and an additional rise in interest rates on vulnerable assets. Due to uncertainty in the financial market, trust in financial institutes will decrease amid the rapid expansion of counterpart risk. Anxiety has grown that the subprime crisis will result in lackluster housing construction, low employment and low consumption, which will lead to an economic slowdown in the United States.
Since August, the central banks in Europe began providing liquidity to ease market concerns. The market has been stabilizing, prompted by Federal Reserve Board's lowering of interest rates by 0.5 percentage point.
But the uncertainty in the global market following the subprime crisis is likely to continue for the time being. Adjustable rate mortgages issued from 2004 to 2006 will become high-rate mortgages, a factor which will possibly destabilize the market. In newly emerging markets, stock markets have been vulnerable to the crisis, but there is little possibility it will have a long-term impact.
Q: Can you explain what the the newly introduced "Capital Market Consolidation Act"is and the prospect for its enactment in the future?
A: The National Assembly has recently passed the "Capital Market Consolidation Act,"which is designed to advance the capital market-related regulations to the level seen in advanced industrial nations. The act seeks to improve the capital markets with the goal of economic growth. The act is the result of several years of effort. For one thing, the stock market, which has been playing a simple broker role so far, will increase in importance with the development of global investment banks. The act consolidates six capital market-related activities with the goal of respecting the creativity of banking institutes while giving investors the maximum protection. Investment banks will be allowed to engage in various kinds of investment activities and design and manage many financial products.
The act also stipulates that investment companies will be required to explain both the possible merits and risks of investment products in a bid to protect investors. It also prevents companies from inducing investors into making excessive investments.
The Korean government believes the introduction of the new capital act will strengthen the competitiveness of Korea's capital market and investment industry. It will also help foreign investment firms engage in free and creative businesses in Korea, which will emerge as a financial hub of Northeast Asia. The government will take all steps necessary to ensure the law will be enacted in February 2009 as planned.
Q: Can you explain the process and future plans for the establishment of a financial hub in Northeast Asia?
A: Since the government set up the plan for the establishment of a financial hub in December 2003, it plans to complete the revision of relevant rules and regulations that will affect the Capital Market Consolidation Act by the end of this year and the amendment of rules pertinent to financial supervision, foreign exchange and capital liberalization.
Beginning next year, the government will enter into the second-stage of the plan with the goal of setting up a "financial hub specializing in asset management,"to enable Korea to compete with advanced financial hub nations like Hong Kong and Singapore by the year 2010.
* In terms of supply, Korea is equipped with enough resources needed to form a financial hub.
Its foreign reserves will total $150 billion by the end of 2007, while it also holds 200 trillion won in the national pension and more than 100 trillion won of insurance income.
In particular, the national pension is expected to increase further, though in the past it took four years to grow the pension by 100 trillion won.
Domestic individual investors have increased their porfolios while the size of the fund trust has reached 300 trillion won.
* The Capital Market Consolidation Act, which was set up in July, is likely to lead to a big bang in the domestic capital market, helping the nation develop into a financial hub.
The government will make continuous efforts to revise laws on banks and insurance to speed up the reform and transparency of the financial sector.
* The Korea Investment Corporation (KIC), established in 2005, is likely to contribute to inducing world-renowned investment banks and asset management companies into the nation, thus helping domestic concerns learn from them regarding financial know-how and renovation.
Additionally, we are now carrying out measures to enable foreign human resources to settle here without difficulties in terms of language and education.
*The financial hub project has been designed to speed up regulatory reform and open the domestic industry to outside competition.
Domestic and foreign companies and capital will be treated equally and engage in fair competition. We will exert our best efforts toward this end.
With the goal of raising our proficiency and know-how, we plan to strengthen the role of the financial graduate school and revised regulations related to certificates so that capable human resources can be readily produced.
* As the policy toward the financial hub in Northeast Asia has been the government's priority in order to upgrade the nation's financial industry and economy, we will strenuously pursue relevant policies with a strong commitment.
Q: How will the Korea-US free trade agreement (KORUS FTA) affect the domestic financial market?
A: The KORUS FTA contains points related to measures on advancing the nation's financial supervision system. It allows new financial services, but under strict conditions. Cross-border trade will be permitted in cases of trading designed to facilitate external trading and activities of financial organizations.
I believe there will be little impact on the financial market in the short term. Our financial industry has already been opened to a large extent and there will be only a slight additional market opening.
But, I believe the FTA will have far-reaching positive effects from a long-term perspective. It will help strengthen the competitiveness of the financial industry. There will be an increasing number of foreign companies advancing into the domestic market, prompted by a comprehensive opening of local branches and new financial services.
The FTA will lead to the introduction of new business know-how and fortify competition, thus strengthening the global competitiveness of domestic companies and benefit the consumers in the end.
We will also introduce administrative guidance through documents and enhance financial supervision and transparency through close cooperation between officials of Korea and the United States. nw

Deputy Prime Minister-Minister of Finance and Economy
Kwon O-kyu