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Document Type

Case Study

Abstract

After the devaluation of the Thai baht in July 1997, international banks reduced their exposures to Korean financial institutions, rating agencies downgraded Korea’s sovereign rating, and the Korean won lost half its value. The government guaranteed all financial institution deposits and provided emergency liquidity support to the financial sector, but these measures did not restore market confidence. In December, Korea sought an International Monetary Fund (IMF) Stand-by Arrangement. As part of the IMF program, the Korean National Assembly consolidated financial sector supervision into a new Financial Supervisory Commission (FSC) and broadened the scope of the Korea Deposit Insurance Corporation (KDIC). The KDIC injected capital into both bank and nonbank financial institutions, beginning with the largest banks in January 1998. The first round of capital injections, between January 1998 and August 2000, focused on financial sector restructuring. The second round, between September 2000 and September 2002, focused on resolving insolvent financial institutions and improving financial supervision and corporate governance. From 2003 onward, the KDIC’s deposit insurance fund was divided into a new deposit insurance fund and a restructuring fund dedicated to ad hoc crisis-related activities. Through 2018, the KDIC and other agencies injected a total KRW 82 trillion of capital by contributing capital directly and purchasing subordinated debt, common stock, and preferred equity. Funded by government-guaranteed bonds, the KDIC injected capital into insured financial institutions, including banks, merchant banks, securities companies, mutual savings banks, and insurance companies. The Korean government argued that the first round of restructuring had succeeded in reducing systemic risk by resolving nonviable institutions and injecting capital into viable ones. Recurring criticisms include concerns with moral hazard and the Korean government’s asymmetric focus on the banking sector. By year-end 2018, the KDIC had recouped about KRW 50 trillion of the KRW 69.4 trillion it spent on capital injections.

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