Korea Stock Exchange 1998 - Report

Case Report – Korea Stock Exchange 1998

Answer the following questions in a brief but straightforward manner:

1. What are the merits and demerits of a stock versus a bank system of financing?

Liquidity is the most obvious advantage of the banking system as you can, most of the times, dispose of money without any transaction fees. The stock exchange in contrast, if you have your money invested, normally for you to be able to liquefy, one has to generally take a slight discount over the market value of the asset, as well as a transaction fee either from the internet platform or the broker bank.

Since investing in the stock exchange has risk adhered to the nature of the most efficient market where prices fluctuate following supply and demand principles, the bank is thought to be a safe place to deposit money and dispose of it whenever someone needs it. The down turn is that banks are always leveraged, this means that everybody cannot withdraw the 100% of their deposits at the same time, this would lead to bank failures and economic stop.

The high risk adhered to the stock exchange comes with a higher interest rate on investment than bank deposits. Banks have the huge advantage that they take small amounts of money from a big part of a country's population, this is called money pooling, and allows them to use it to supply lots of, even though expensive, loans to many individuals and small business that otherwise could not obtain from the stock exchange.

The stock exchange has a huge up-turn, it can provide with a significant amount of long term capital into businesses that identify opportunities to capitalize from and share those revenues.

1. To prevent another bad loan problem in the future, what changes should be made in South Korean banks?

A lot has been done thanks to the crisis to correct this problem, as part of the deal with the IMF, Korean corporations had to undergo major changes in structure and governance at every level. As well, the Financial Supervisory Commission is now supervising all financial institutions, including banks. The banks that were bailed out by the government were asked for major changes in management and close sight off operations until the restructuring is completed, and recapitalization is achieved. The elimination of mutual guarantees for loans among affiliated firms is also very important.

1. Is it a good idea for South Korea to rely more on the stock market as a source of corporate finance? Is it a good idea from the perspective of chaebols?

We believe it is. Being more open to the stock market allows new options to raise capital, which is one of the critical economic gaps in this business case. Also, given the difficult context in which the local banks were submerged, having more options for capital allocation is definitely a good idea. Additional to this, the stock market brings along more visibility and controls, specially from the outside; foreign investors enable “world-class management and governance practices to Korea”. The Chaebols also benefit from this type of best-practices that are incorporated with the incursion of international capital, as per the Business Case, it pretty much was a requisite from the IMF as part of the Bailout package, to re-structure the Chaebols, include this type of governance and open them to foreign investment.

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