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Lessons from Savings Bank Scandal

Yun Chang-hyun

Professor of Business Administration TheUniversity of Seoul

If a company goes bankrupt, its corporate bonds are generally regarded as junk. These junk bonds are the

least favored among investors. Of course, some investors, like vulture funds, make profits by investing in

distressed companies or properties, though the strategy is not easy to implement.

When Jinro, a leading Korean liquor maker, went bankrupt in the late 1990s, most domestic investors reacted

with skepticism. But U.S. investment bank Goldman Sachs, well aware of the competitive edge of Jinros

products, bought its corporate bonds with a face value of nearly 1 trillion won (about US$950 million). The

purchase price was estimated at around 20 percent of the bonds nominal value. The investment in Jinro

eventually proved a resounding success. In the end, Jinro turned itself around in a dramatic fashion and

Goldman Sachs pocketed tremendous profits.

The business boundary of the so-called investment banks has considerably diversified. The investment banks

make money through various strategies, including brokerage, trading, discretionary transaction and investment

advisory service on financial investment products. Among these, principal investment and dealing, in which

securities and other financial products are bought under their own accounts, are important sources of income.

Goldman Sachs is known to be very competitive in principal investment. In fact, the U.S. investment bank

massively disposed of its real estate-related bond positions shortly before the global financial and economic

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crisis and earned additional profits by investing in short positions, in which profits build if prices fall. Goldman

Sachs even made enormous profits from credit default swaps, demonstrating its enigmatic capabilities in

financial transactions.

The unfolding corruption scandal at the suspended Busan Mutual Savings Bank is in the news a lot these days.

The bank is accused of embezzling its largest shareholders, bribing and lobbying government officials, and

illegally informing major depositors about its imminent shutdown, allowing them to withdraw their money. The

banks operations were suspended in February for being insolvent due to massive illegal project loans.

Busan Mutual Savings Bank had been the countrys biggest savings bank by assets. It is now accused of taking

out nearly 5 trillion won in illegal loans to set up 120 special purpose companies. According to prosecutors

investigating the case, much of the investment now remains unaccounted for. The probe is still under way.

Apart from the huge bribes allegedly offered to politicians and civil servants, the lenders irregularities can be

called the scandal of the century.

A savings bank accepts deposits and pools those funds to provide credit, either directly by lending, or

indirectly by investing through the capital markets. It takes advantage of the interest margin. Contrary to

commercial banks with nationwide branch networks, savings banks are supposed to focus on lending to

regional business interests. However, Busan Mutual Savings Bank had stepped out of line, as continued

deregulation allowed its business scale and scope to be expanded. A cat began to act like a tiger.

According to recent reports by the Korea Economic Daily, the regional savings bank set up an ambitious goal

of joining the ranks of global investment banking groups, like Goldman Sachs or JP Morgan, and pushed for

excessive business expansion. It aimed to become a commercial investment bank, which combines a

commercial bank with the function of credit reception and an investment bank specializing in capital

management. In the longer term, it allegedly envisioned a comprehensive financial services and investmentgroup after establishing or acquiring a securities company, an asset management company and an investment

advisory company.

Busan Mutual Savings Bank was supposed to take deposits from individual and corporate clients and carefully

make loans to other households and firms. But the lender established special purpose companies by itself

before making loans to them and taking full responsibility for their asset management. In short, the savings bank

pretended to be an investment bank and arbitrarily spent clients deposits without diversifying its investment

portfolio. Indeed, the bank concentrated its investments in real estate development projects. It even pumped

nearly 500 billion won into real estate development projects in Cambodia.

Busan Mutual Savings Bank is accused of establishing nine special purpose companies under false names to

develop highways, islands and an airport for Cambodias Camco C ity Project. Most of the banks

development projects in Cambodia were halted and the whereabouts of its funds remain unknown, according

to prosecutors who suspect most of the money was used to raise secret funds.

A dream doesnt always become reality. Such a large-scale development project can be daunting for even the

most competitive and fortunate investor. But this savings bank recklessly pushed ahead with the mega-project

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and perished solemnly, leaving behind a lot of lessons.

Financial business operates on the basis of other peoples money, which can be simply defined as hazardous

material. A financial company is an institution authorized to deal with the hazardous material. Financial

company employees are experts in handling hazardous materials, which must be managed very carefully, safely

and in accordance with manuals. One single mistake can kill other people as well as the employees themselves.

The Busan Mutual Savings Bank case has taught us the importance of going back to the basics in a painful

manner.

2011-07-25