Regulatory and Developmental Problems Raised by the Concentration of Wealth

– Lessons from East Asia

Michael Pomerleano

The World Bank

Regional Workshop on NBFIs in Africa

December 9 – 11, 2003

Mauritius

Recurring themes in East Asia

Large family control in more than half of East Asian corporations. Significant cross-country differences do exist, however. Corporations in Indonesia and Thailand are mainly family-controlled. And state-control is significant in Indonesia, Korea, Malaysia, Singapore, and Thailand *.

Interlocking ownership structures Ownership structures where the economic benefit is

higher than the actual ownership (voting rights consequently exceed formal cash-flow rights); , cross guarantees .

Monopolization of Financing: Bank Lending, Corporate Bond Issuance, Equity Issues

Source: Who Controls East Asian Corporations, by Claessens, Djankov and Lang, 1999

The Case of Indonesia, Thailand, Malaysia: Concentration of ownership is rampant and free float is minimal

The Case of Indonesia: Interlocking group ownership structures affiliated with banks such as BCA… 80% of credit flowed to the tops 20 groups

In Korea, the Growth of NBFIs Had Been Very Rapid Until 1997 Crisis The share of NBFIs in domestic financial market became larger than banks b

y late-1980s . The Rapid Expansion of NBFIs was owed to a large extent to regulatory arbitr

age NBFIs were not subject to directed credit program. NBIFs were privately-owned (many by chaebols) Interest rate control on NBFIs’ products was less restrictive Supervision over NBFIs was loose

The Case of Korea

Growth of Banks and NBFIs Credit

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Top-Five Chaebol Monopolization of Financing

• Bank Lending

•Corporate Bond Issuance

• Rights Issues

• Commercial Paper…

Balance Sheets of Big Three Investment Trust Companies (owned by the chaebols) vs. Regional Investment Trust Companies (Unit: KRW billion)

1997 1998 1999

Three ITCs Regional ITCs

Three ITCs Regional ITCs

Three ITCs Regional ITCs

1. Assets 6,805.7 2,748.0 6,570.0 3,809.8 7,705.8 1,132.9 1.1. Current Assets 5,686.1 2,217.9 4,393.6 3,285.4 2,925.0 670.8 1.2. Non-Current Assets 1,119.6 530.1 2,176.1 524.1 4,780.9 462.1 2. Liabilities 7,579.3 2,589.1 10,129.5 3,869.3 10,448.8 1,125.2 2.1. Current Liabilities 7,366.5 2,538.5 10,068.8 3,831.6 8,291.1 1,114.0 (Debt) (7,057.8) (2,362.4) (9,827.9) (3,379.6) (5,525.6) (1,089.9) 2.2. Non-Current Liabilities

212.6 50.5 60.4 37.3 2,157.7 11.2

3. Owner's Equity -773.6 158.9 -3,559.5 -59.6 -2,743.0 7.7 3.1. Contributed Capital 520.0 600.0 610.2 280.0 610.2 370.0 3.2. Capital Surplus -1,293.6 -141.1 -4,169.7 -339.6 -3,353.2 -362.3 ( Net Income ) (-933.2) (-104.5) (-2,966.2) (-301.6) (199.1) (-91.6)

Trust Assets of Investment Trust Companies and Investment in Big Five Chaebols' Securities ….lending was equally concentrated…. (Unit: KRW billion)

The Big Five Chaebols

Total Total Hyundai Samsung Daewoo LG SK

CP 510,886 247,972

48.5%

85,402

(16.7%)

41,068

(8.0%)

59,385

(11.6%)

45,345

(8.9%)

16,773

(3.3%)

Stock 99,258 47,125

47.5%

9,077

(9.1%)

16,234

(16.36%)

1,646

(1.7%)

10,185

(10.3%)

9,982

(10.1%)

Corporate Bonds 1,543,219 626,339

40.6%

148,354

(9.6%)

123,574

(8.01%)

188,469

(12.2%)

103,991

(6.7%)

61,950

(4.0%)

Sub total 2,153,363 921,437

42.8%

242,834

(11.3%)

180,876

(8.40%)

249,500

(11.6%)

159,521

(7.4%)

88,705

(4.1%)

Total trust assets 2,447,233 37.7% 9.9% 7.4% 10.2% 6.5% 3.6%

!!!!!

Interest Rates Movement and the Growth of Investment Trust Companies

CorporateBond Yield

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CommercialPaper Yield (Left)

ITC (Right)

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Change in the Structure of Financial Market

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Credit Unions

Investment Trust

Gov., Public & Financialbonds

Corporate Bonds

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The Korean Experience suggests :

•Developments of securities markets and NBFIs that allowed the top 5 chaebol to control the NBFIs sector was fraught with peril and lead to fragility.

•The development of NBFIs needs to be based on a solid regulatory framework.

⇒ ‘spare tire’ can also get flat.

Korea’s Response

Consolidation of troubled financial Institutions Priority was given to merchant banking companies (MB

Cs) There was gradual strengthening of regulatory rules on

insurance and small savings institutions Investment and Trust companies(Investment Trust Co

mpanies) were largely left out of the focus of restructuring until the Daewoo collapse (July 1999), but regulation strengthened since 1999.

Reorganization and consolidation of supervisory institutions after the crisis in Korea

Consolidation of Troubled Financial InstitutionsJune 2001

Types of Institutions

　Financial Restructuring

　 　

License MergerDissolut

ion Total Percent New

End of 97

Revoked

　 　 　%

established

At Jun.2001

Commercial Banks

　36 5 6 - 11 33.3 - 25

NBFIs　

2,068 116 142 321579 28 50 1,539

　Merchant Banks 30 22 5 - 27 90 1 4

　Securities Companies 36 5 1 1 7 19.4 16 45

　Insurance Companies 50 5 6 4 15 30 3 38

　 Investment and Trust Companies

30 6 1 - 723.3 6 29

　 Mutual Sav. &Finance Companies

231 67 26 25 11851.1 12 125

　Credit Unions 1666 2 102 291 395 23.7 9 1280

　Leasing Companies 25 9 1 - 10 40 3 18

Total 2,101 121 148 321 590 28.1 50 1564

source: MOFE, 2001.8

Reorganization and consolidation of supervisory institutions after the crisis in Korea

Central Bank(BOK) MOFE

Special FinancialInstitution

Banking Securities Insurance CreditUnions

FSC

FSS

•The impact of large financial institutions and large corporates on regulatory policy needs to be recognized as well. Their powerful influence can shape public policy initiatives. Elite firms resist policy initiatives that are detrimental to their interests. It often leads to regulatory capture, and self serving policies.

What can be concluded from the East Asia experience? Some concluding thoughts - Part I • A weak infrastructure leads banks to favor lending to large well established firms (“name” lending… fewer information and enforcement problems) . Therefore credit is concentrated.. It leads to monopolistic practices, lack of competition, and lack of innovation.

•A deficient underlying infrastructure- i.e., the necessary legal, enforcement, information and supervisory capacity- inhibits access to credit for all firms (as well as SMEs).

•A sound “arbitrage proof” regulatory framework is essential;

•Groups- be it chaebols in Korea, groupos in Latin America or any others- that have banks and NBFIs as part of the group structure…in the past it invariably lead to vulnerabilities and occasionally to crisis;

•Policies designed to increase the distribution of ownership – such as the development of institutional investors- will have a salutary impact on stability.

•For discussion…. Your reactions?

What can be concluded from the East Asia experience? Some concluding thoughts - Part II