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KoreanEconomic

FinancialReview

&

Vol.16 | No.2 | April 2011

President and Publisher

Tae-Joon Kim [email protected]

Contributors (in alphabetical order)

[email protected]

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[email protected]

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[email protected]

[email protected]

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[email protected]

Junghan Koo

Jae-Youn Lee

Kyoobok Lee

Myungwhal Lee

Soonho Lee

Sukho Lee

Yoonsok Lee (Editor)

Hyungjoon (Ray) Lim

Hyoung-Seok Lim

Hyoungsik Noh

Sungwook Park

Jeong Ho Suh

Christopher Byungho Suh

Thomas Steinberger (English Editor)

The Korean Economic and Financial Review, April 2011, Vol.16, No.2. The

KEFR is published four times a year (January, April, July, October) by the

Korea Institute of Finance. Permission to reproduce any portion of this work for

non-commercial purposes or classroom use should be obtained from the Korea

Institute of Finance, (822) 3705-6108, KFB Building, 4-1 Myung-Dong 1-Ga,

Chung-Ku, Seoul, Korea 100-021

Copyright 2011 by the Korea Institute of FinanceSeoul, Korea. All Rights Reserved

Printed by KM

Printed on April 30, 2011

Registration No. Ma-02619

Registration on December 17, 1996

Contents

Overview (Yoonsok Lee)

ⅠⅠ. Macroeconomic DevelopmentsA. Demand and Supply 9

1. Aggregate Demand (Hyoung-Seok Lim, Sungwook Park) 9

2. Aggregate Supply (Hyoung-Seok Lim) 16

B. Inflation (Kyoobok Lee) 19

1. Oil and Import Prices 19

2. Domestic Inflation 21

C. Macroeconomic Outlook for 2011 23

1. Global Economy and Balance of Payments (Sungwook Park) 23

2. Economic Growth (Myungwhal Lee) 25

3. Inflation (Kyoobok Lee) 28

ⅡⅡ. Financial Markets and IndustryA. Asset Prices(Kyoobok Lee, Sungwook Park, Hyungjoon (Ray) Lim) 29

1. Recent Trends 29

2. Outlook for 2011 32

B. Money and Credit (Kyoobok Lee) 34

C. Financial Industries 37

1. Banking Industry (Hyoungsik Noh) 37

2. Non-Banking Financial Institutions (Soonho Lee) 40

3. Securities Industry (Junghan Koo) 45

4. Insurance Industry (Sukho Lee) 47

ⅢⅢ. Current IssuesA. Korea's Credit Card System & Potential Measures

(Jae-Youn Lee) 52

B. The Role of Private Finance in Helping Korean Firms Win

Overseas Projects (Jeong Ho Suh) 56

C. Policy Agenda for Domestic Banks' Foreign Expansion

(Christopher Byungho Suh) 60

Macroeconomic Developments

The domestic economy has maintained its underlying

upward trend on the strength of high growth shown by

exports, even though consumption and facilities invest-

ment have faltered. The Korean exports are likely to

remain strong, and the improvement in domestic

demand, such as facilities investment, will be further

enhanced. These economic forecasts, however, still

remain uncertain due to the risk factors in domestic and

overseas economies.

Outlook for 2011

The Korean economy in 2011 is anticipated to continue

remaining on a robust recovery path. We forecast a

GDP growth of 4.4% for 2011 resulting from an expan-

sion in both domestic demand and exports growth.

Growth is forecast to be 4.0% and 4.7% y.o.y. in the

first and second half, respectively. By the component of

expenditures, exports and private consumption are

expected to increase by 12.2% and 3.3% y.o.y. respec-

tively. We expect also facilities investment and con-

struction investment to be 6.9% and △0.4% y.o.y.

respectively in 2011.

The Korean economy continued to show strong growth in the first quarter of 2011 amid strongexports although consumption and facilities faltered. Despite worries of rapid increase in globalcommodity prices and possible negative effects of the Japan earthquake, we maintain our growthforecast of 4.4% in 2011. We lowered our expected current account surplus to 12.0 billion USD in2011 due to higher import expectations and also revised our won forecast to 1,075. While Koreanbanks deleveraged in the fourth quarter of 2010 we expect growth opportunities to rebound in thefirst half of 2011. During the fourth quarter of 2010, assets of credit card companies increased 7.1%to 54.5 trillion won partly due to recent rapid increase in credit card loans. Meanwhile profitability ofsecurities companies is expected to rise as brokerage commissions is expected to increase due tothe rising transaction volumes.

Overview

Korean Economic and Financial Review [April 2011]4

Export and imports are expected to increase 15.6% and

21.4%, respectively, in 2011. Therefore, the balance of

payments is expected to register a current account sur-

plus of 12.0 billion USD in 2011, smaller than the 28.2

billion USD figure from the previous year. The reduc-

tion should occur mainly from a faster recovery of

imports than exports and rising raw materials prices.

Financial Markets

In the first quarter of 2011, money market rates mostly

increased following a change in the monetary policy by

the Bank of Korea. Meanwhile, long-term market inter-

est rates decreased slightly as investors’ risk aversion

increased due to the Japanese earthquake and nuclear

accident and the unrest in North Africa and the Middle

East and so on. As the base rate of the Bank of Korea is

expected to increase additionally in the rest of 2011

with high inflationary pressure, Treasury bond (3yr)

yields in 2011 are expected to be 4.0%, or 0.3%p higher

than 2010.

In 2011, the won/dollar exchange rate is expected to

average 1,075, down from the 1,156 figure of 2010.

The rate is to be affected by the continuous current

account surplus in Korea, foreign portfolio investment

inflows and the extended easing policy by the Fed. The

downward trend in the won/dollar exchange rate will,

however, be slowed by high raw materials prices and

remaining uncertainties in the international financial

markets.

The Korea Composite Index (KOSPI) ended the first

quarter of 2011 at 2,107 points, up 37 points from the

beginning of the year. The index has been negatively

affected by the Middle Eastern liberalization and the

Japanese earthquake, but managed to recover owing to

the robust buying of institutional investors. In the sec-

ond quarter, Korea’s equity market is expected to have

balanced upside and downside risks.

Overview 5

Money and Credit

In January and February of 2011, the money supply

continued to increase, but at a slower pace. M2 and Lf

growth fell to 5.7% and 5.9% in those period versus

7.4% and 8.3% in the fourth quarter of 2010.

During the first quarter of 2011, total depository banks’

corporate and household lending increased 12.6 trillion

won and 3.0 trillion won each. In 2011, corporate and

individual bank lending is expected to continue to rise

as the solid growth of real economy and high loan

demand from high inflation. However, its growth will

be limited by a rise in the base rate.

Financial Industries

In the fourth quarter of 2010, Korean banks’ assets sig-

nificantly decreased with a meager increase in loans.

Net income decreased over the previous quarter thanks

to a decrease in non-interest income while interest

income increased with the help of an increase in net

interest margins. Both loan loss provisions and bad debt

expenses decreased. The asset soundness substantially

improved whereas the BIS capital adequacy ratio

slightly went down. Growth opportunities for Korean

banks are expected to rebound in the first half of 2011.

Net income is expected to continue to improve. The

asset soundness and the capital adequacy ratio are

expected to ameliorate slightly.

In the fourth quarter of 2010, most non-banking finan-

cial institutions experienced asset growth. The net

income of non-banking financial institutions was posi-

tive except for Mutual Savings Banks and Agricultural

Cooperatives. Excluding installment financing compa-

nies and MSBs, the loan soundness of non-banking

financial institutions improved. Except for Mutual

Credits, capital adequacy also improved. Since the

competition between credit card companies and credit

finance companies become increasingly heated, operat-

ing expenses are expected to increase. Owing to poten-

tial insolvent loans, MSBs and MCs will be required to

adequately manage credit risks.


The assets of securities companies increased 21.9% to

199.8 trillion won during the fourth quarter of 2010, up

from 164 trillion won in the same quarter last year. This

was attributable to the increase in marketable securi-

ties, especially in bond holdings, which were up 20.7

trillion won. Securities companies’ profits increased

188.9% over the same period last year to 780 billion

won driven by increased brokerage commissions and

fees from asset management service. Capital adequacy

fell 37%p compared with the same quarter last year.

Despite higher net operating capital, total value at risk

rose due to the higher exposure to interest rate risk.

At the end of the third quarter of FY2010, premium

income of life insurers recorded 23.3 trillion won, up

4.3% y.o.y. Direct premiums written for non-life insur-

ers during the same period were up 28.6% y.o.y. to 12.8

trillion won. Total assets and premium income of the

life insurance industry during the first quarter of

FY2011 are expected to grow due to an upturn in the

sales of variable life insurance and continued inflow in

premium income from savings type insurance. Non-life

insurers are expected to maintain the growing trend,

driven by, in particular, long-term non-life insurance.

Current Issues

We have three papers that deals with current issues at

hand. The first paper covers the problems of the current

credit card system and potential measures to resolve

dissatisfaction among merchant members. Rapid

growth and competition in Korea’s credit card market

led to an expansion in benefits for card user members.

The costs of these benefits have been passed on not to

large merchant members but smaller ones because card

companies held the power to determine the merchant

fees of the latter exclusively in the 3-party scheme.

Mandating a merchant member pool system may allow

us to enjoy the benefits of the 4-party scheme while

maintaining the current 3-party scheme because it can

help improve bargaining power over large merchants

for the card companies. The second paper touches on

the role of private finance on supporting overseas pro-

jects of Korean firms. With the flurry of infrastructure

Overview 7

investment by resource-rich countries amid recent high

oil prices, competition has been heating up to win

orders for large-scale plants. In order to support mid-

/long-term demand for FX financing effectively, the

functions of Korea’s export credit agencies (ECAs)

should be strengthened first and foremost. However. as

there are limits to ECAs’ funding capacity, Korea also

need to enhance the competitiveness of private finan-

cial companies in the longer-term. ECAs, financial

companies, and supervisory authorities must design a

shared road-map for strengthening the private financial

sector, and push ahead with the globalization of

Korea’s financial industry. The last paper deals with the

policy agenda of domestic banks’ foreign business

expansion. It is imperative for the Korean government

to encourage domestic banks’ globalization through

foreign expansion. However, the institutional environ-

ment for domestic banks’ foreign expansion is not

friendly yet: Korean banks are required to keep their

loan exposure to each foreign country below 10%; it is

impossible for Korean banks to change the purchase

condition upon tender offer abroad; foreign sub-

sidiaries of domestic banks need to provide collateral

when they borrow money form their parent company;

and each foreign branch is subject to evaluation as an

independent entity. The government should abolish

rules that restrict domestic banks’ foreign expansion

and promote challenging so that domestic banks can

leap forward.


A. Demand and Supply

1. Aggregate Demand

Hyoung-Seok Lim ([email protected])

The domestic economy has maintained its underlying

upward trend on the strength of high growth shown by

exports, even though consumption and facilities invest-

ment have faltered. The domestic economy will keep

up its underlying trend, even in the presence of external

risks.

Real GDP (chained volume measure) increased 4.2% in

the first quarter of 2011. That primarily reflected posi-

tive contributions from expanded exports of goods &

services. On the production side, manufacturing

increased by 9.9% and services 2.8%. On the expendi-

ture side, facilities investment and exports went up by

12.0% and 16.8%, respectively, in the first quarter of

2011.

Domestic shipments and export shipments increased by

11.5% and 18.2%, y.o.y. in the last year and 6.3% and

15.7% y.o.y, respectively, in February 2011 (Figure

Ⅰ.1).

Macroeconomic Developments 9

The Korean economy continued to show signs of strong growth in the first quarter of 2011 althoughgrowth in consumption and facilities investment have been sluggish to that of last year. World tradevolumes climbed by 12.4% y.o.y. in 2010, following the uptrend in the global economy. It will contin-ue to have a positive effect on exports and improve domestic demand, such as that for facilitiesinvestment. However, there are also risk factors both at the domestic and international level.Domestically, the household debt, which has reached its historical levels, will be one of the seriousrisk. Internationally, sovereign debt problems in the Eurozone and inflationary pressure due to sharprise of oil and raw materials continue to be a challenge for the Korean economy.

Ⅰ.Macroeconomic Developments 1

FigureⅠⅠ.1 Monthly Shipments Indices

Source: National Statistical Office (NSO).

FigureⅠⅠ.2 Industrial Production Index

Source: NSO.

Industrial production and service industry production

have maintained their upward trend. Industrial produc-

tion index, following a 11.7% upswing in the fourth

quarter of 2010, increased by 13.4% and 9.1% y.o.y. in

January and February, respectively (Figure Ⅰ.2). Ser-

vice industry activity index registered 3.2% and 0.2%

increase y.o.y. in the fourth quarter of 2010 and Febru-

ary respectively in 2011 (Figure Ⅰ.2).

Economic Growth

The underlying upward trend of the Korean economy

continues to expand, even in the presence of external

risk. In particular, exports have continuously gone up.

Consumption and facilities investment slightly con-

tracted temporarily in the first quarter of 2011.

The economic growth rate, following a 4.7% y.o.y. in

the fourth quarter of 2010, increased by 4.2% y.o.y. in

the first quarter of 2011. Facilities investment

increased 12.0% y.o.y. in the first quarter of 2011,

including machinery and transport equipment invest-

ments. However, construction investment declined by

11.9%.

Exports in the national accounts grew 16.8% y.o.y. in

the first quarter of 2011, with an upswing in exports of

such items as semi-conductors, automobiles and

machinery. Imports also expanded 10.8% y.o.y. in the

same period.

In March, the trade surplus totaled $3.1 billion, up from

$2.46 billion in February. Exports rose 30.3% y.o.y.,

reaching an all-time high of $48.6 billion. Exports for

the first quarter of 2011 also set a new record with

$131.8 billion. Meanwhile, imports gained 27.9% to

record $45.5 billion. Higher energy prices drove up

inbound shipments of raw materials, which posted a

31.7% increase.


TableⅠⅠ.1 Economic Growth Trends

(Unit: %, y.o.y.)

Source: BOK.

2010 2011

1Q 2Q 3Q 4Q Year 1Q

G D P 8.5 7.5 4.4 4.76.2

4.2(q.o.q) (2.1) (1.4) (0.6) (0.5) (1.4)

Consumption 5.9 3.4 3.4 3.0 3.9 2.7

Private 6.6 3.5 3.6 2.9 4.1 3.0

Government 3.4 2.9 2.5 3.2 3.0 1.6

Investment 12.5 6.8 6.8 3.4 7.0 △2.2

Construction 4.3 △2.3 △3.1 △2.9 △1.4 △11.9

Facilities 29.1 30.5 26.6 15.9 25.0 12.0

Exports 16.7 14.5 11.6 15.7 14.5 16.8

Imports 21.5 18.0 14.7 14.2 16.9 10.8

GNI 9.6 5.6 4.5 3.0 5.5 -

FigureⅠⅠ.3 Service Industry Activity Index

Source: NSO.

FigureⅠⅠ.4 Export (f.o.b.) Growth

Source: Bank of Korea (BOK).

1.1 Domestic Demand

Aggregate consumption growth increased to 2.7%

y.o.y in the first quarter of 2011 from 3.0% y.o.y. in the

previous quarter. Private consumption showed sus-

tained growth, rising 3.0% y.o.y., while government

consumption modestly increased, growing to 1.6%,

after rising 3.2% in the previous quarter. The contribu-

tion of aggregate consumption to economic growth

reached 1.9%p, down slightly from 2.0%p in the previ-

ous quarter (Table Ⅰ.2).

Fixed investment declined 2.2% y.o.y. in the first quar-

ter of 2011. Facilities investment has kept on a marked

increase, rising 12.0% from the same period of the pre-

vious year, even though construction investment has

continued to be subdued. Fixed investment’s contribu-

tion to the real GDP growth was △0.5%p in the first

quarter of 2011 (Table Ⅰ.2).

Private Consumption

Private consumption in the national accounts rose 3.0%

y.o.y. in the first quarter, as expenditures on durables

exhibited high upward trends, and those on non-

durables and semi-durables also shifted to an increase.

This reflected increasing household buying power and

positive consumer confidence (Table Ⅰ.1). The con-

sumption-related economic indicators, however,

slightly contracted due to temporary factors such as

Lunar New Year holidays.

The consumer goods sales index declined 0.8% y.o.y.,

from 10.6% in January, due to temporary factors such

as the holiday season in February. By sector, the con-

sumption of durable and quasi-durable goods showed

an increase of 9.0% and 2.3%, respectively, compared

to 14.0% and 11.1% in January, while that of non-

durable goods declined 6.9%, compared to 9.3% of the

previous month. (Figure Ⅰ.6).

The service sector also has managed positive growth.

The service industry activity index increased 4.6% and


TableⅠⅠ.2 Contributions to Real GDP Growth

(Unit: %p)

Source: BOK.

2010 2011

1Q 2Q 3Q 4Q Year 1Q

G D P 8.5 7.5 4.4 4.76.2

4.2(q.o.q) (2.1) (1.4) (0.6) (0.5) (1.4)

Consumption 4.3 2.4 2.3 2.0 2.7 1.9

Private 3.8 1.9 1.9 1.5 2.2 1.6

Government 0.6 0.5 0.4 0.5 0.5 0.3

Investment 3.2 2.1 2.0 1.1 2.0 △0.5

Construction 0.7 △0.5 △0.6 △0.6 △0.3 △1.8

Facilities 2.4 2.7 2.5 1.6 2.3 1.2

Inventories 2.7 4.0 1.2 0.3 2.0 △0.2

Net Exports △1.8 △1.0 △1.0 1.3 △0.6 3.1

FigureⅠⅠ.5 Contributions to Real GDP Growth

Source: BOK.

FigureⅠⅠ.6 Monthly Index of ConsumerGoods Sales

Source: NSO.

0.2% y.o.y. in January and February 2011, respectively

(Table Ⅰ.3).

At the sector level, finance & insurance, transportation,

business activities, and health & social work sectors

contributed in particular to output growth, while the

real estate & leasing was sluggish, recording △20.2%

y.o.y. in February, due to the real estate downturn

(Table Ⅰ.3).

The Consumer Expectations Index, a measure of

prospects for six months ahead in comparison with the

current situation, fell by 19.0 points to record 75 from

March’s 94, dropping below the benchmark of 100.

The Consumer Evaluation Index, a measure of current

situation in comparison with six months earlier,

recorded 64 in March, down 18.0 points from Febru-

ary’s 82 (Figure Ⅰ.7).

Real gross national income (GNI) increased 5.5% over

the previous year but this growth was smaller than that

of the real gross domestic product due to the deteriora-

tion of the terms of trade. (Figure Ⅰ.8). Per capita GNI

grew by US$ 3,566 to US$ 20,759 from US$ 17,193 in

2009.

Fixed Investment

Fixed investment growth in the national accounts

decreased 2.2% y.o.y. in the first quarter of 2011

reflecting construction investment which declined

11.9% y.o.y., owing to to an increase in civil engineer-

ing which offset the shrinkage of investment for build-

ing construction (Table Ⅰ.1), after diminishing △2.9%

in the fourth quarter of 2010. Facilities investment

including machinery and transport equipment invest-

ments, however, increased 12.0%.

Estimated equipment investment growth (current

value) was 26.6% and 0.7% in January and February,

respectively, buoyed by the decrease in machinery

investment (26.6% and 0.7% y.o.y., respectively).


FigureⅠⅠ.7 Consumer Sentiment Indices

Source: NSO.

FigureⅠⅠ.8 GDP, GDI, and Private Consumption

Source: BOK.

TableⅠⅠ.3 Service Industry Activity Indexby Type

(Unit: %, y.o.y.)

Source: NSO.

2010 2011

Year 4Q Sep. Jan. Feb.

Service Industry Activity 3.9 3.2 2.5 4.6 0.2

Wholesale & Retail 5.7 4.7 4.2 8.2 △1.0

Hotels & Restaurants 1.2 1.7 0.0 △0.4 △0.3

Transportation 12.0 10.0 12.0 8.4 4.4

Telecommunications 1.9 3.6 5.3 8.1 1.5

Finance & Insurance 4.6 8.2 7.9 8.0 7.2

Real Estate & Leasing △8.6△24.28△25.3△19.2△20.2

Business Activities 7.5 0.6 8.9 8.7 4.3

Education 2.0 3.1 4.4 4.3 -1.8

Health & Social Work 8.8 4.6 2.5 6.3 3.6

Culture & Sporting △0.4 2.7 △4.4 1.7 0.0

Domestic machinery orders (current value), a leading

indicator, accelerated modestly to 26.7% in January

from 19.7% in February due to the sustained upward

trend in the private sector and the rebound to increase in

the public sector.

The Business Survey Index (BSI) issued by the Bank of

Korea, which measures the level of confidence in the

Korean economy, dropped to 89 points in the first quar-

ter of 2011, from 92 points in the last quarter (Figure

Ⅰ.10). Similar indices produced by the Federation of

Korean Industries and the Korea Chamber of Com-

merce & Industry also showed comparable findings.

Construction Investment, a leading indicator, has been

tepid due to a xmodest decline in related indicators.

Construction Orders, a leading representative indicator,

were sluggish. Domestic construction orders registered

△16.7% growth in February 2011, due to the poor per-

formance shown by the public sector despite the rise in

the private sector (△35.7% y.o.y.). Construction com-

pleted (current value) also fell, slipping to △19.2% in

February, and thus continued the downward movement

from the previous month (△11.0%), due to increasing

sluggishness in construction and civil works.

From October 2008, the Bank of Korea shifted to an

expansionary monetary policy, with the base rate low-

ered from 5.25% to 2.00%, its historically lowest level.

The Bank of Korea, however, decided to raise the base

rate in January (from 2.5% to 2.75%) and March (from

2.75% to 3.0%) due to concerns about consumer price

inflation. Looking ahead, bank interest rates will be

readjusted as necessary to engender a continued upturn

in economic activity and inflation.

1.2 External Demand and theBalance of Payments

Sungwook Park ([email protected])

Even though the world economic recovery continues,

the pace of activity remains geographically uneven.


FigureⅠⅠ.9 Monthly Equipment InvestmentIndices

Source: NSO.

FigureⅠⅠ.10 Business Survey Index

Source: BOK, Federation of Korean Industries (FKI),Korea Chamber of Commerce & Industry (KCCI).

FigureⅠⅠ.11 Monthly ConstructionInvestment Indices

Source: NSO.

FigureⅠⅠ.12 Real Interest Rateand BOK Base Rate

Source: BOK.

The US economy increased at an annual rate of 3.1%

q.o.q. in the fourth quarter of 2010, an increase from the

2.6% in the third quarter. Personal consumption expen-

ditures increased 4.0% q.o.q. in the fourth quarter of

2010, following an increase of 2.4% in the previous

quarter.

In contrast to private consumption, private fixed invest-

ment grew 6.8% q.o.q. in the fourth quarter, following

an increase of 1.5% q.o.q. in the previous quarter.

Exports of goods & services grew 8.6% q.o.q. from an

increase of 6.8% q.o.q. in the previous quarter. Imports

of goods & services decreased △12.6% q.o.q.. Mean-

while, the US unemployment rate recorded 8.8% in the

first quarter of 2011.

The Eurozone economy grew in the fourth quarter by

2.0% y.o.y. from 2.0% y.o.y. in the previous quarter,

boosted by strong performance in Germany and Swe-

den, which grew 4.0% and 7.2% y.o.y., respectively.

The main drag on the Eurozone was Greece, whose

GDP continued to contract by △6.6% y.o.y in the

fourth quarter of 2010. Eurozone private consumption

increased 1.1% y.o.y, and government spending rose by

0.6% y.o.y.. Exports and imports rose 11.6% y.o.y. and

10.7% y.o.y., respectively, in the fourth quarter. Mean-

while, eurozone unemployment has remained 10.0% in

the first quarter of 2011, slightly below the historical

high of 10.7% in January of 1997.

Japan’s GDP decreased at an annual pace of △1.3%

q.o.q., in the fourth quarter of 2010, driven by a

decrease in private consumption and exports. Private

consumption decreased △0.8% q.o.q. in the fourth

quarter from 0.9% q.o.q. in the third quarter. Private

residential investment rose 2.9% q.o.q., compared with

an increase of 1.8% q.o.q. in the previous quarter. Pub-

lic demand recorded △0.6% q.o.q. in fourth quarter

compared with △0.2% in the previous quarter. Exports

of goods & services decreased △0.8% q.o.q. in the

fourth quarter, down from the 1.5% in the previous

quarter. Meanwhile, Japan’s employment situation still

remains severe, although movements of an incipient

recovery could be seen shortly. The unemployment rate


TableⅠⅠ.4 Major Countries’ Economic Growth(Unit: %, q.o.q.)

Note: Annual rates from previous period.1) Bloomberg, y.o.y.2) ECB, Data refer to the Euro 17, y.o.y.

Source: Bureau of Economic Analysis, EurostatCabinet Office, Government of Japan

2009 20102010

1/4 2/4 3/4 4/4

US △2.6 2.8 3.7 1.7 2.6 3.1

Japan △6.3 3.9 6.1 2.1 3.3 △1.3

China1) 9.2 10.3 11.9 10.3 9.6 9.8

EU2) △4.1 1.8 0.8 2.0 2.0 2.0

Germany △4.9 3.6 2.1 3.9 3.9 4.0

France △2.5 1.6 1.2 1.6 1.7 1.5

Sweden △5.3 5.5 2.6 4.4 6.8 7.2

Greece △2.3 4.5 △0.7 △5.0 △5.1 △6.6

TableⅠⅠ.5 Major Countries’ UnemploymentRates (Unit: %)

Source: Bloomberg.

20092010 2011

1/4 2/4 3/4 4/4 1/4

US 9.3 9.7 9.6 9.6 9.6 1.4

Japan 5.1 4.9 5.2 5.1 5.0 4.8

Eurozone1) 9.5 10.0 10.0 10.0 10.0 10.0

TableⅠⅠ.6 Balance of Payments(Unit: 100 mil. USD)

Source: BOK.

2009 20102010 2011

2/4 3/4 4/4 1/4

Current Account 327.9 282.1 88.58 99.31 91.61 27.2

Goods 378.7 419.0 122.4 125.4 123.4 59.5Exports(f.o.b.) 3,581.9 4,642.9 1,175.9 1,182.6 1,270.9 1,277.0

Imports(f.o.b.) 3,203.2 4,223.8 1,053.5 1,057.2 1,147.5 1,217.5

Services △66.4 △112.3 △18.7 △29.6 △22.0 △25.4

Training 52.4 92.5 20.5 24.6 31.9 25.1

Travel △52.2 △79.0 △13.6 △27.0 △18.5 △22.4

Income 22.8 7.7 △10.1 13.0 △0.7 3.9

Current Transfers △7.1 △32.3 △5.0 △9.5 △9.1 △10.8

Exports (f.o.b.) 3,653.3 4,663.8 1,202.4 1,163.2 1,287.5 1,313.0

(%, y.o.y.) (△13.9) (28.3) (33.1) (22.7) (23.8) (29.9)

Imports (c.i.f.) 3,230.8 4,252.1 1,056.3 1,057.0 1,157.3 1,232.9

(%, y.o.y.) (△25.8) (△31.6) (42.8) (24.6) (24.6) (25.6)

recorded 4.8% in the first quarter of 2011, down from

5.0% in the fourth quarter of 2010.

The Chinese economy grew at 9.7% y.o.y. in the first

quarter of 2011, up from 9.8% y.o.y. in the fourth quar-

ter of 2010. Total retail sales of consumer goods

increased 16.3% y.o.y. in the first quarter of 2011.

Investment in fixed assets rose 25.0% y.o.y. in the same

period above. China’s investment in real estate devel-

opment recorded 34.1% y.o.y. in the first quarter of

2011.

Korea’s current account surplus recorded 9.2 billion

USD in the fourth quarter, down from 9.9 billion USD

in the third quarter of 2010, but remained positive

thanks to brisk exports backed by the global economic

recovery. The current account accumulated a surplus of

28.2 billion USD from the year of 2010.

The goods account surplus recorded 12.3 billion USD

in the fourth quarter to hit 12.5 billion USD in the third

quarter, with global economic conditions improving in

neighbor economies and trading partners. In particular,

daily exports averaged a high level of 1.9 billion USD

in September of 2011. The MENA region weathered

the global crisis relatively well, and while the recovery

is now in process, economic growth varies widely

across the region. In Japan, there are large uncertainties

associated with the Tohoku earthquake.

The services account deficit stood at 2.2 billion USD in

the fourth quarter, from 3.0 billion USD in the third

quarter, as travel expenses increased while transport

expenses decreased.

The income account shifted to a deficit of 67.6 million

USD in the fourth quarter from a surplus of 1.3 billion

USD due to the increase in dividend payments overseas.

Moreover, the current transfers account deficit recorded

0.9 billion USD during the fourth quarter from the 1.0

billion USD deficit in the third quarter of 2010.

Exports (customs-cleared basis) rose 28.9% y.o.y. to 48

billion USD from February to March 2011. Imports


TableⅠⅠ.8 Exports and Export Growth By Sector(f.o.b., Units: 100 mil. USD, %, y.o.y.)

Note: ( ) denotes export growth.Source: Korea International Trade Association (KITA)

2009 2010 2011

4/4 1/4 2/4 3/4 4/4 1/4

Vessels115.3 98.9 146.7 114.1 131.4 165.6

(△11.8) (△8.4) (10.1) (20.4) (13.9) (67.4)

Petroleum & 69.4 62.9 80.0 80.5 92.4 106.9Derivatives (5.4) (44.0) (54.1) (24.0) (33.0) (70.0)

Machinery75.0 77.7 92.0 89.1 102.2 107.3

(△7.3) (33.2) (43.7) (25.2) (36.3) (38.1)Wireless 76.1 66.3 61.3 65.4 83.2 70.7Communication (△8.9) (△10.3) (-22.9) (-18.6) (9.3) (6.6)Equipment

Automobiles81.3 74.4 94.2 83.8 101.8 97.5

(△6.9) (51.2) (62.0) (28.0) (25.1) (31.1)Semi- 103.7 106.9 129.4 141.3 129.4 122.2

conductors (73.3) (120.7) (84.1) (60.8) (24.7) (14.3)Petro- 76.7 85.4 90.8 87.1 93.8 109.0

chemicals (35.0) (58.3) (33.3) (14.8) (22.3) (27.6)

Steel60.0 58.8 71.7 73.9 84.5 84.4

(△13.6) (14.8) (14.7) (30.3) (40.9) (43.6)

Liquid 69.8 67.2 75.8 82.5 73.6 66.6Devices (78.4) (64.1) (34.8) (22.3) (5.6) (△0.8)

Automobile 39.3 41.6 46.1 46.9 55.1 54.0Parts (37.9) (107.3) (74.7) (49.3) (40.2) (29.8)

Computers 23.7 22.4 22.7 20.2 25.9 21.2(25.4) (33.7) (19.1) (-1.9) (9.1) (△5.0)

TableⅠⅠ.7 Monthly Exports and Imports(Unit: 100 mil. USD, y.o.y %)

Source: Korea Customs Service

2010 2011

Sep. Nov. Dec. Jan. Feb. Mar.

Total 394.1 412.6 441.5 446.2 386.1 480.7

Growth 16.2 21.4 22.6 45.2 16.9 28.9Rate

Daily 18.8 17.2 18.0 19.4 20.3 20.0Exports

Total 350.0 386.7 400.6 418.0 362.0 452.9Growth 17.6 30.9 21.7 32.6 16.6 27.3Rate

Daily 16.7 16.1 16.3 18.2 19.1 18.9Imports

Trade 44.1 25.9 40.9 28.2 24.1 27.8Balance

Exports

Imports

increased 27.3% y.o.y. to 45.3 billion USD in the same

period.

Export volume in most key industries was up signifi-

cantly. In particular, automobiles, automobile parts,

steel, petrochemicals, vessels and semi-conductors has

continued to expand due to the pick up in overseas

demand. Stronger exports such as petroleum and deriv-

atives, machinery and wireless communication equip-

ment increased continuously. However, exports of liq-

uid devices and computers decreased 29.1% y.o.y. and

39.9% in the first quarter of 2011 from an increase of

9.3% and 9.1% y.o.y in the fourth quarter of 2010,

respectively.

Growth rates of Korea’s exports to countries increased

in the first quarter of 2011. Exports to China, Korea’s

top overseas market, grew 17.8% y.o.y. in the first quar-

ter of 2011. Exports to ASEAN countries and the US

rose 39.5% and 19.7% y.o.y., respectively, in the first

quarter of 2011, while shipping abroad to the EU

recorded 36.0% y.o.y in the same period. Exports to the

Middle East jumped 32.2% y.o.y., or 7.6 billion USD,

in the same period.

2. Aggregate Supply

Hyoung-Seok Lim ([email protected])

Potential Growth

Potential growth measured by smoothing real GDP

growth rates has been still hovering around 3% which

means real GDP growth can attain 3% without inflation

or other adverse effects by fully utilizing its resources.

However, recently, it has increased slightly. This was

mainly because real GDP growth has been high since

the fourth quarter of 2009 on the strength of the world

economic recovery, as well as the base effects.

Viewing potential growth from a long-term perspec-

tive, it peaked at 10.8% during 1986 and 1987. Since

then, the rate has been in a steady decline. The major


FigureⅠⅠ.13 Real and Potential GDP Growth

Note: Potential growth rate was estimated using by HP-

Filtering.

Source: BOK.

TableⅠⅠ.9 Exports by Region(Unit: $100 mill, %, y.o.y.)

Note: 1) ( ) denotes export growth.Source: KITA.

2009 2010 2011

4/4 1/4 2/4 3/4 4/4 1/4

China 254 266 291 292 320 313(45.6) (61.0) (38.9) (22.6) (25.8) (17.8)

Japan 62 60 68 73 81 89(△5.2) (28.6) (33.2) (24.6) (31.4) (49.9)

EU 136 115 147 129 144 157(6.3) (13.5) (22.1) (19.7) (5.5) (36.0)

ASEAN 121 116 138 130 148 162(18.3) (46.1) (39.2) (17.7) (22.4) (39.5)

US 100 105 130 127 136 126(△12.2) (26.8) (36.6) (29.8) (35.3) (19.7)

Latin 76 77 99 97 90 100America (△5.4) (39.5) (67.8) (24.9) (17.4) (30.2)Middle 63 57 76 67 84 76East (△10.1) (10.6) (14.7) (13.4) (31.7) (32.2)

FigureⅠⅠ.14 Total Fertility Rate

Source: NSO

factor behind the downward trend is population

changes like the low birthrate and rapid aging. Births

per female in 2000 and 2010 was 1.21 on average, com-

pared to 1.62 in 1987 and 1996. Meanwhile, the birth

rate increased in recent years after falling to 1.076 in

2005, but the number of newly-born babies remained

unchanged. These factors might lead to a long-run

slowdown in input growth. Further, the global financial

crisis also harmed potential growth.

Total Factor Productivity

Growth accounting analysis using the Cobb-Douglas

production function with human capital shows that

Total

Factor Productivity (TFP) has made up 1.01%p of the

4.58% real GDP growth for the period from 2000 to

2010. It accounts for effects in total output not

explained by the amount of inputs used in production.

During the period from 2000 to 2010, TFP’s portion of

real GDP growth was 22.2% (TFP/GDP growth), lower

than the 23.2% for the 10 years from 1987 to 1996

(Table Ⅰ.10).

Meanwhile, in 2010, TFP’s contribution turned to posi-

tive after two consecutive years of negative figures, as

real GDP increased 6.2% in 2010. During 2008 and

2009, the contribution of TFP growth was negative.

Especially, in 2009, it was △1.0%p of the 0.2% real

GDP growth (based on 2005 prices) after comprising

△0.3%p of the 2.3% real GDP growth in 2008. It was

because employment in 2009 decreased 0.3% and gross

capital formation decreased 15.0%, due to the global

financial crisis (Figure Ⅰ.15). Decreasing TFP during

the global financial crisis indicates that the economy

has been less efficient.

R&D intensity (R&D expenditures as a percentage of

GDP) which is considered to be one of the most impor-

tant determinants of TFP growth has been increasing

steadily (Figure Ⅰ.16). This shows that TFP growth

will remain robust as long as R&D is conducted effi-


TableⅠⅠ.10 Contributions of TFP and FactorInputs to Average GDP Growth

(Unit: %, %p)

GDP Physical HumanGrowth TFP Capital Capital Labor

’87~’96 8.67 2.01 3.62 0.94 2.11(A)

’00~’10 4.58 1.01 1.98 0.55 1.04(B)

(B)-(A) △4.09 △1.00 △1.64 △0.39 △1.07

FigureⅠⅠ.16 R&D as of GDP

FigureⅠⅠ.15 Recent Trends in TFP and FactorInputs to Average GDP Growth

Source: National Science & Technology Commission

(NTIS)

Source: BOK, NSO, KIF.

Source: BOK, NSO, KIF.

ciently and effectively.

Labor Input and Human Capital

From 2000 to 2010, the annual contribution of labor to

economic growth averaged 1.04%p, down from

2.11%p between 1987 and 1996 (Table Ⅰ.10). This

slowdown can largely be attributed to the slower

growth of the labor force, or economically active popu-

lation, over the past decade (Figure Ⅰ.17). During this

period, the average population growth of those aged

15-64 dipped to 0.58% from 1.67% between 1987 and

1996 (Figure Ⅰ.17). Also, labor’s portion of real GDP

growth (labor/GDP growth) over the past decade fell to

22.6% from 24.3% for the prior 10 year period.

This indicates that the Korean economy has become

less labor-intensive. As the population growth rates

decreases, the slowdown in labor is expected to con-

tinue for many years to come (Figure Ⅰ.17).

The annual contribution of human capital or quality of

labor to economic growth averaged 0.55%p from 2000

to 2010, lower than 0.39%p for the 10 years from 1987

to 1996 (Table Ⅰ.10). However, the quality of labor,

measured in terms of average years of schooling, has

improved over time, albeit at a diminishing rate (Figure

Ⅰ.18).

The recent economic slowdown, which was brought on

by the global financial crisis, led to not only an increase

in the average years of schooling to 11.5 years from 9.7

years from 1987 to 1996 (Figure Ⅰ.18) but also a

decrease in youth employment (ages 15-29).

Youth employment growth continued to decrease,

while employment of those aged 30~59 has been on the

rise and employment of those aged 60 and over has

continued to increase.

These structural unemployment issues therefore remain

a lurking threat to the Korean economy’s potential

growth (Figure Ⅰ.19).


FigureⅠⅠ.19 Employment Changes by Age

Source: NSO.

FigureⅠⅠ.18 Labor Force Growth andAverage Years of Schooling

Source: NSO, KIF

FigureⅠⅠ.17 Population Growth Rates(Projections)

Source: NSO.

Physical Capital

Slow physical capital growth is the primary factor

behind the long-run slowdown in potential economic

growth. In recent years, its slowdown has been much

more pronounced than that of either labor inputs or

human capital (Figure Ⅰ.15).

The average annual contribution of physical capital to

economic growth from 2000 to 2010 was 1.98%p,

1.64%p off the 3.62%p attained in the 1987 to 1996

period (Table Ⅰ.10). Meanwhile, in 2010, equipment

investment growth was 25.0%, which may increase

future capital accumulation, with the economic recov-

ery and the base effects of 2009.

In fact, from a long-run perspective, a slowdown in the

rate of capital accumulation usually occurs in a devel-

oping country that is coming off several decades of

rapid growth. In Korea’s case, the capital-output ratio

has been rising steadily, implying that many previous

investment opportunities have been drying up (Figure

Ⅰ.20).

B. Inflation

Kyoobok Lee ([email protected])

1. Oil and Import Prices

Crude oil Prices

Crude oil prices (including WTI, Brent and Dubai)

increased steeply during the first quarter of 2011, as the

geopolitical problems in the Middle East and North

Africa, including the continued insurgency in Libya

triggered from Tunisia and Egypt, continued. Egypt

plays an important role in international energy markets

through the operation of the Suez Canal and the

SUMED pipeline which is a global thoroughfare for oil

traffic, linking Europe to the Middle East and Asia.


FigureⅠⅠ.20 Capital-Output Ratio

Source: BOK.

FigureⅠⅠ.21 Oil Prices

Source: Bloomberg.

Furthermore, not only supply disruptions but also fears

about the possible spread of unrest to major exporters

have pushed prices higher. There are recent fears that

violence in Nigeria related to the country’s national

election could lead to supply interruptions. A massive

blackout appears to have affected some refineries in

Venezuela, making oil prices, especially Brent crude,

climb above $120 a barrel. Generally in Europe, Brent

crude sourced from the North sea and crude oil

imported from North Africa, a former European colony.

Therefore, the unrest in Africa greatly influenced the

Brent crude price. According to the IEA, OPEC’s

“effective” spare capacity, which excludes Iraq,

Venezuela and Libya, is estimated at 4.08 million barrel

a day, its lowest level since late-2008.

The weak dollar also encouraged the uptrend in prices.

The dollar has traditionally influenced the price of oil

and other commodities, including gold and base metals,

which are mostly priced in the currency and usually

move to compensate for changes in the its value. The

dollar/euro exchange rate increased to 1.44 in April

after lowered to 1.28 in January 2011.

On the other hand, global oil demand also has risen. It

was 89.0 million barrels a day in the first quarter 2011,

versus 86.5 million barrels a day during the same quar-

ter of 2010. Specifically, oil demand of China increased

to 9.9 million barrels a day in the first quarter 2011, up

from 8.9 million barrels a day of the first quarter 2010.

Not only emerging market counties’ demand is

increased, but also the speculation purpose demand

may also be increased. It is presumed that net purchases

of non-commercial oil was 2.64 million contracts in the

first quarter 2011, compared to 1.87 million contracts in

the last quarter of 2010 (Figure I.23). A contract means

a thousand barrel.

In addition, a non-opec’s oil supply in the first quarter

2011 also decreased 0.2 million barrels a day compared

to the fourth quarter 2010, as Alaskan output decreased

because of pipeline-related shut-ins in January. OPEC

crude oil output in February fell by 95 thousand barrels

a day to 30.05 million barrels a day.


FigureⅠⅠ.23 Import and Export Price Indices(Won-denominated)

Source: BOK.

FigureⅠⅠ.22 Non-commercial Crude Oil NetPurchase

Source: Bloomberg.

As a result, oil prices increased above $100 in the first

quarter 2011 from $80 of the fourth quarter 2010. And

recently it moved between $105 and $115 a barrel.

Import Prices

Won-denominated import prices increased 15.5% y.o.y.

in January and February of 2011, higher than the 9.7%

y.o.y. in the fourth quarter 2010. The prices in raw

materials, including crude oil, rose 28.4% y.o.y., lead

the import price growth. Also agricultural products’

prices increased 37.0% y.o.y., forest products’ prices

increased 44.4% y.o.y. and mineral fuels’ prices

increased 23.3% y.o.y.. However, capital goods prices

which has decreased since October 2009 decreased

0.7% during the first tow months in 2011.

Meanwhile, dollar-denominated import prices rose

18.5% y.o.y. in January and February of 2011, lower

than the figure of won-denominated import prices. Raw

materials and intermediate materials denominated in

dollar rose 31.7%, 13.9% y.o.y. respectively. Also those

of capital and consumer goods increased 1.9% and

5.0% y.o.y., respectively, during the same period.

These gaps between won-denominated import prices

and dollar-denominated import prices were attributable

to the fact that the y.o.y. change in the won/dollar

exchange rate decreased 2.5%, or averaged 1,119 in the

first two months of 2011, compared to 1,148 over the

same period in 2010.

Similarly, while export prices denominated in dollars

rose 8.0% in the fourth quarter, those denominated in

won increased 5.3% y.o.y.

2. Domestic Inflation

In the first quarter 2011, consumer and producer price

growth continued to increase, mainly led by farm prod-

ucts and industrial products. The PPI increased more

sharply than the CPI. Therefore, it is expected that the

CPI will rise more steeply because producer prices typ-

ically have a lagged effect on consumer prices.


FigureⅠⅠ.25 CPI, PPI, and Core Inflation

Source: NSO.

FigureⅠⅠ.24 Won-denominated ImportedPrices

Source: BOK.

Producer Prices

In the first quarter 2011, producer prices climbed 6.7%

y.o.y., 1.7%p higher than the last quarter 2010. The

prices growth of agricultural, forest & marine products

fell to 21.0% y.o.y. in the first quarter from 23.7% of the

previous quarter, but still high. Also, the prices of indus-

trial products rose by 7.9% y.o.y. in the first quarter

2011, compared to 5.3% in the fourth quarter of 2010.

Service prices rose just 1.9% y.o.y.. Even though the

prices in professional, scientific & technical services

(which include architectural design, engineering, and

fees for CPAs and tax accountants) increased 3.6% and

the ones in financial services, including brokerage fees

and premiums, rose 5.3%, telecommunication service

prices decreased for five consecutive quarters and the

price of leasing & renting and advertising decreased

0.1%, 0.6% y.o.y., respectively, in the first quarter 2011.

Especially, in March, PPI growth was up 7.3%, which

is the fastest pace since November 2008.

This is because the costs for fresh vegetables and indus-

trial goods jumped. Prices for agricultural, forest and

marine products jumped 16.2% y.o.y. in March, with

live stock prices up 19.9% y.o.y. in the month. How-

ever, the price growth of vegetable was lowered to

5.3% in March as the cold weather has eased. Industrial

products’ prices, including products ranging from tex-

tiles to oil, plastics and computers, climbed 9.1% y.o.y.,

the highest since November 2008.

Consumer Prices

The Consumer Price Index (CPI) rose 4.5% y.o.y. in the

first quarter 2011, which exceed the BOK’s target range

(between 2.0% and 4.0%). The CPI for living necessi-

ties increased 4.9% in the first quarter, reflecting higher

prices for groceries.

Specifically, in the first quarter, consumer prices in the

agriculture, forestry and fishing sector increased 16.6%

and those in industrial products increased 5.0% higher


FigureⅠⅠ.26 Contributions to Consumer PriceInflation

Source: NSO, KIF

TableⅠⅠ.11 CPI and PPI

(Unit: %, y.o.y.)

Source: BOK.

2010 2011

3Q 4Q 1Q Jan. Feb. Mar.

CPI 2.9 3.6 4.5 4.1 4.5 4.7

Agriculture and 12.5 19.2 16.6 17.5 17.7 14.9Fishing

Industrial 2.5 2.8 5.0 4.3 5.0 5.9

Service 2.6 3.8 2.4 2.2 2.5 2.5

PPI 3.6 5.0 6.7 6.2 6.6 7.3

Agriculture, Forestry, 11.7 23.7 21.0 26.6 20.8 16.2and Fishing

Industrial 3.9 5.3 7.9 6.8 7.8 9.1

Services 1.3 1.8 1.9 1.8 1.9 2.1

than 2.8% of the fourth quarter 2010.

Especially, in March, consumer prices rose 4.7% the

highest level since October 2008. Notably, while con-

sumer prices growth in the agriculture, forestry and

fishing sector has decreased, industrial products prices

has increased since December 2010, mainly due to the

increase in oil prices.

Core CPI growth, which excludes oil and food costs,

also rose to 2.9% in the first quarter 2011, 1.0%p higher

than the previous quarter’s.

Real Wages

In the fourth quarter 2010, real wages for all industries

increased just 0.7% (y.o.y.) on average, lower than the

4.9% (y.o.y.) of the third quarter 2010. While real wages

in construction and financial intermediation increased

3.4%, 6.8% respectively, real wages for manufacturing

decreased 0.5% y.o.y. and the wholesale & retail sector

decreased 0.9% in the quarter. Furthermore, real wages

for the food & lodging sector continued to decrease by

1.6% for the fifth consecutive quarter.

C. Macroeconomic Outlook for2011

1. Global Economy and Balance ofPayments


The global economy should continue its moderate

recovery in 2011 according to the recent forecast by the

IMF. Fears that growth in advanced countries might lose

steam, after restocking process and fiscal stimulus come

to an end, and thus face a risk of a double-dip recession

have been fading. The world economy is expected to

grow at 4.4% in 2011 with advanced economies grow-

ing at 2.4% and emerging and developing economies


FigureⅠⅠ.27 Real Wage Growth

Source: Ministry of Employment and Labor (MoEL),

BOK, KIF

growing at 6.5%, which implies that the recovery

remains uneven throughout the world. In the mean time,

prices for crude oil has been rising sharply mainly due to

the political unrest in the Middle East and North Africa

and high demand boosted by economic recovery. Soar-

ing oil prices and inflation in emerging economies pose

new risks to a stable recovery of the world economy.

The US economy is expected to recover at the growth

rate of 2.8% in 2011 with easing financial conditions

supporting private demand and external demand. The

US government helped boost the economic growth

with the Federal Reserves’s second round of quantita-

tive easing (QE2) and fiscal package approved in

December 2010. Healthy corporate balance sheet and

pent-up demand for durables may surprise on the

upside in the future. On the other hand, while labor

market seems to improve, unemployment rate of 8.8%

in March is still too high and the decline in the housing

market does not seem likely to stop soon.

The IMF forecasts 9.6% growth for the Chinese econ-

omy in 2011, following the 10.3% growth in the previ-

ous year. The drivers of growth seem to shift increas-

ingly from public to private demand. Inflation has

become one of the major policy concerns as CPI infla-

tion is about to move up above 5% y.o.y even after a

series of increases in the required reserve ratios and

hikes in the interest rates. Nevertheless, fears of a sharp

decline in the growth of the Chinese economy due to

overdone tightening seem to have subduing.

The Japanese economic growth is expected to slow to

1.4% in 2011 from 3.9% in 2010. As for the future fore-

cast, there are many uncertainties associated with the

recent Japanese earthquake which occurred in March. In

addition to the direct damage of capital stock after the

earthquake, possible power shortages and ongoing risks

associated with the crises at the nuclear power plant

pose further downside risks to the economic growth.

The Eurozone economy is forecast to grow modestly

and unevenly at a pace of 1.6% in 2011. The core

economies such as Germany, France and Italy should


TableⅠⅠ.13 Economic Outlook for EmergingCountries

Source: IMF WEO (April 2011).

(Unit: %)

Countries 2010Projections

2011 2012

Emerging and7.3 6.5 6.5Developing Economies

Commonwealth ofIndependent States 4.6 5.0 4.7

Developing Asia 9.5 8.4 8.4

Latin America and the 6.1 4.7 4.2Caribbean

Middle East and North Africa

3.8 4.1 4.2

Sub-Saharan Africa 5.0 5.5 5.9

Central and 4.2 3.7 4.0Eastern Europe

TableⅠⅠ.12 Economic Outlook for MajorTrade Partners

Source: International Monetary Fund World EconomicOutlook (IMF WEO) (April 2011).

(Unit: annualized GDP q.o.q.%)

2010Projections

2011 2012

World 5.0 4.4 4.5

Advanced 3.0 2.4 2.6countries

US 2.8 2.8 2.9

China 10.3 9.6 9.5

Japan 3.9 1.4 2.1

Euro Area 1.7 1.6 1.8

grow only gradually at the rate of 2.5%, 1.6%, and

1.1% respectively in 2011 due mainly to the fiscal con-

solidation and the slowdown in external demand

growth. The growth in the periphery of the euro area is

projected to be much lower because of a sharp contrac-

tion in public and private balance sheets and severe

structural unemployment problems.

In emerging markets, economic growth is expected to

remain high in 2011, boosted by accommodative

macroeconomic policies, rising global demand for

commodity prices and strong domestic demand. In the

meanwhile, inflation pressure should broaden. In par-

ticular, developing Asian economies are expected to

continue to expand rapidly and post 8.4% growth, fol-

lowed by economies in the Sub-Saharan Africa and the

Latin America which should grow 5.5% and 4.7%,

respectively, in 2011.

In Korea, the balance of payments is expected to regis-

ter a current account surplus of 12.0 billion USD in

2011, smaller than the 28.2 billion USD figure from the

previous year. The anticipated reduction stems from

expectations of a faster recovery of imports and travel

abroad than that of exports in 2011. Export and import

growth are expected to increase 15.6% and 21.4%,

respectively, for the year.

2. Economic Growth

Myong-Hwal Lee ([email protected])

The Korean economy has maintained its upward trend.

On the production side, manufacturing and services

increased by 9.9% and 2.8% y.o.y. respectively in the

first quarter of 2011. On the expenditure side, facilities

investment and exports have grown consistently, while

construction investment has decreased since the second

half of last year. The employment conditions continued

to improve, as the number of employed persons went

up by 442 thousand persons y.o.y. and the unemploy-

ment rate marked 4.2% in the first quarter of 2011.


TableⅠⅠ.14 Balance of Payments Forecast

Notes: 1) Figures in parentheses represent percent changes from the previous year.

2) Period average.Source: BOK and KIF.

(Unit: 100 mil. USD)

20102011

1st half 2nd half Year

Current Account 282 49 71 120

Goods 419 144 139 285

Service·Income·△137 △97 △68 △165

Current Transfers

Exports (f.o.b.) 4,664 2,646 2,746 5,392(Growth, %)1) (28.3) (19.6) (12.0) (15.6)

Imports (c.i.f.) 4,252 2,527 2,636 5,163(Growth, %)1) (31.6) (24.0) (19.1) (21.4)

Won/Dollar 1,156 1,100 1,050 1,075Exchange Rate2)

The Cyclical Indicator of Coincident Composite Index

(CCI), a barometer of current economic conditions,

registered at 100.6 in February 2011. The 12-month

Smoothed Change in Composite Leading Index, which

predicts the turning points in business cycles, fell by

0.6%p from the previous month, registering 2.4% in

February(Figure Ⅰ.23). These imply concerns over the

uncertainties in domestic and overseas economic con-

ditions.

The global economy has improved faster than expected

from the global financial turmoil. The major advanced

economies have kept up their paces of recovery and the

emerging market economies have also continued to

show strong performances. World trade volumes

climbed by 12.4% y.o.y. in 2010, following the uptrend

in the global economy. It will continue to have a posi-

tive effect on exports and improve domestic demand,

such as that for facilities investment.

However, there are also risk factors in domestic and

overseas economies. The Eurozone’s sovereign debt

problems, such as those of Portugal and Spain, may act

as a downside risk factor for the global economy. In

addition, international oil prices, which have skyrock-

eted due to the political uncertainty in the Middle East

and North Africa, will stay on a high level. Emerging

countries as well as some advanced economies are also

increasingly concerned about inflationary pressure as

the prices of oil and raw materials increase sharply.

Finally, the aftermath of the Great East Japan Earth-

quake is expected to have some negative impacts on

some manufacturing companies in the short run.

Medium- and long-term impacts will, however, be

moderate.

Meanwhile, there are also several domestic risk factors.

The household debt, which has reached its historical

levels, will be one of the serious risk factors. It

approached approximately 800 trillion won at the end

of 2010. In addition, the sluggish real estate market and

the increase in leasehold deposits are about to spread

negatively to the real economy. The upward trend in

inflation is another concerns in Korea. There is a grow-


FigureⅠⅠ.29 Contributions to HouseholdConsumption Expenditures

Source: BOK.

FigureⅠⅠ.30 Rate of Change in Inventories

Source: NSO.

FigureⅠⅠ.28 CCI and CLI

Source: NSO.

ing possibility that the high inflation rate will persist in

the coming months. The Bank of Korea’s monetary

policy is expected to be further tightened in order to

curb inflation.

Gross Domestic Product

The Korean economy in 2011 is anticipated to continue

remaining on a robust recovery path. We forecast a

GDP growth of 4.4% for 2011 resulting from an expan-

sion in both domestic demand and exports growth.

Growth is forecast to be 4.0% and 4.7% y.o.y. in the

first and second half, respectively (Table Ⅰ.15).

By the component of expenditures, all expenditure sec-

tors are expected to bolster except for construction

investment. In particular, exports, boosted by the con-

tinuing upward trends in the global economy, are antic-

ipated to show robust growth. Exports are forecast to

increase by 13.9% and 10.7% in the first and second

half, respectively. Overall, exports are expected to

increase by 12.2% in 2011.

Private consumption growth is also expected to stage a

sustained recovery in 2011 thanks to a rise in asset

prices, such as the increase in stock prices. However,

the increase in private consumption will be restricted

by the effects of the supply-side shock, such as higher

oil prices, and the interest burden on households due to

the interest rate hike of the Bank of Korea. Private con-

sumption is forecast to increase by 3.3% in 2011.

We expect facilities investment to be 6.9% in 2011,

with the rapid growth led by rising global demand and

improvements in corporate earnings. Internal and

external economic uncertainty and the price of interna-

tional oil and raw materials, however, may act as down-

side risk factors of facilities investment.

Construction investment has continued to be muted. It

is anticipated to show a slightly positive growth though

since the public sector will lead the increase in con-

struction investment, centering around SOC invest-

ment. Construction investment is forecast to increase at


FigureⅠⅠ.32 Estimated Index of EquipmentInvestment

Source: NSO.

FigureⅠⅠ.31 Consumption Indices

Source: NSO.

TableⅠⅠ.15 2011 Macroeconomic Outlook(Unit: %, y.o.y.)

2010 2011

1st 2nd Year 1st 2nd Yearhalf half half half

G D P 8.0 4.5 6.2 4.0 4.7 4.4

Consumption 4.6 3.2 3.9 2.8 3.6 3.2

Private 5.1 3.3 4.1 3.0 3.5 3.3

Investment 9.3 5.0 7.0 △0.7 5.8 2.7

Construction 0.4 △3.0 △1.4 △7.3 5.8 △0.4

Equipment 29.8 21.0 25.0 9.1 5.0 6.9

Exports 15.5 13.7 14.5 13.9 10.7 12.2

Imports 19.7 14.5 16.9 10.4 11.6 11.0

an annualized rate of △0.4% in 2011, by △7.3% and

5.8% in the first and second half, respectively.

3. Inflation


Inflation (as measured by changes in the CPI) in 2011 is

forecast to be 4.2%, 1.3%p higher than 2010. In the

first half of 2011, inflation is expected to be in the mid-

4% range.

There are persistently high cost-push inflation pressure

in the economy like the increase of oil and raw material

prices and agriculture and forestry prices. In addition to

that, demand-pull inflation pressure with the solid

growth of the real economy. However, this high infla-

tion pressure may be alleviated a little bit by the

decreasing trend of the won/dollar exchange rate and

the government policy to decrease the consumer price.


TableⅠⅠ.16 Inflation Forecasts(Unit: %, y.o.y.)

20102011

1st half 2nd half Year

CPI 2.9 4.6 3.7 4.2

PPI 3.8 7.0 5.8 6.4

Notes: Figures are 2011 forecasts.

FigureⅠⅠ.33 Contributions to ConstructionInvestment Growth

Source: BOK.

29

A. Asset Prices

1. Recent Trends


Interest Rates

In the first quarter of 2011, money market rates mostly

increased following a change in the monetary policy by

the Bank of Korea. Meanwhile, long-term market inter-

est rates decreased slightly as investors’ risk aversion

increased due to the Japanese earthquake and nuclear

accident and the unrest in North Africa and the Middle

East.

The Monetary Policy Committee (MPC) of the Bank of

Korea decided to raise the base rate four times since

November 16, 2010, mainly due to the continued

upward inflationary pressure associated with the con-

tinued upswing in activity and the run-up in interna-

tional raw material prices.

Since the increase in the base rate, CD rates (91 days)

have gone up to 3.40% from 2.66%. CP rates (91 days)

also increased to 3.61% from 2.79%.

Meanwhile, treasury bond yields (3-yr) decreased as

global financial market’s uncertainty increased due to

We expect the Bank of Korea to tighten its monetary policy as the economy continues to strengthenand inflationary pressure still linger. We revised our Treasury bond (3yr) yields slightly higher to4.0%, 0.3%p higher than 2010. Continuous current account surplus, foreign portfolio investmentinflows and the ongoing monetary easing policy by the Fed will strengthen the won and we expectan average of 1,075, down from the 1,156 figure of 2010. Both upside and downside risks seem toco-exist in the equity market. Growth opportunities for Korean banks are expected to rebound in thefirst half of 2011. Assets of credit card companies increased 7.1% to 54.5 trillion won and profitabili-ty of securities companies is expected to improve due to expected increase in trading volumes.Premium income of the life insurance industry in FY2011 are forecasted to increase as sales in vari-able life insurance and savings type insurance show strong growth prospects.

Ⅱ. Financial Markets and Industries 2

Figure ⅡⅡ.1 Major Short-Term Interest Rates

Source: BOK.

Figure ⅡⅡ.2 Major Long-Term Interest Rates

Source: BOK.

the massive earthquake and the nuclear accident in

Japan and the geopolitical unrest in the Middle East and

North Africa region, including Libya and Egypt. Also,

in the bond market, foreign investors’ domestic bond

investment shifted to a slight net buying position since

January 2011. Foreigners’ net purchases was 3.0 tril-

lion won in March, 2.5 trillion won in February and 1.0

trillion won in January. As a result, while treasury bond

yields (3-yr) were above 3.9% before the Japanese

earthquake, it recently hovered the level of 3.7%.

This trend matched major countries' treasury bond

rates. While the bond yields of major countries includ-

ing the US, Germany, the UK and Japan decreased as

global financial uncertainty increased through Febru-

ary to mid-March, they have turned upward and been

steadily rising since late March.

This is because the expectations of economic recovery

increased and the uncertainty about Japan eased after

the G7 decided to intervene to control the yen rise on

March 18.

On the other hand, corporate bond yields moved in sync

with treasury bond yields. After corporate bond yields

(AA-, 3yr) increased to 4.51% in February, they

decreased to 3.89% on March 15, 2011. Recently, how-

ever, it rose to 4.56% in April. Consequently, the credit

spreads on corporate bonds sustained the level of 75bps

~ 80bps.

Exchange Rates


During the first quarter of 2011, the won appreciated

3.5% against the U.S. dollar. While the won/dollar had

fluctuated within a narrow band from January till the

middle of March, it fell down below 1,100 relatively

fast in the late March. The fall in the won/dollar rate

reflected not only Korea's strong fundamentals but also

the recent rise in inflation in Korea. It was widely

accepted in the market that the Korean government


Figure ⅡⅡ.3 Major Countries’ Treasury BondRates (5yr)

Source: Bloomberg.

Figure ⅡⅡ.4 Won/Dollar Exchange Rate andWon/Yen Exchange Rate

Source: BOK.

would have less incentive to intervene in the foreign

exchange market since the appreciation of the won

would help slow down inflation. Consequently, the

won/dollar rate stood at 1096.7 by the end of March.

The euro rose 5.8% to 1.4158 USD by the end of

March, up from 1.3387 USD at the end of 2010. This

was partly due to the expectation that the ECB would

start to raise its policy rate soon and normalize the mon-

etary policy earlier than other major central banks. In

fact, the ECB has decided to raise its policy rate by 25

basis points to 1.25% on April 7th.

The yen/dollar appreciated to 76.25 on March 17 from

81.52 on December 31, driven by the explosion in the

nuclear power plant. However, the G7 governments’

coordinated intervention since March 18 succeeded in

lifting up the yen/dollar rate above 80. Eventually, the

yen/dollar depreciated 1.5% to 82.8 between the end of

December and the end of March.

Stock Prices

Hyungjoon (Ray) Lim ([email protected])

The Korea Composite Index (KOSPI) ended the first

quarter of 2011 at 2,107 points, up 37 points from the

beginning of the year. In early January, KOSPI contin-

ued an upward trend from last year, breaking 2,100

points on January 14. Then the spread of the Egyptian

liberalization movement following Morgan Stanley's

bearish call on Korean equities on January 21 began

pushing KOSPI downward. From the yearly low 1,928

points on March 2, KOSPI had been gaining until the

Japanese earthquake again moved the index back to

1,924 on March 15. As oil producing countries vowed

to increase their oil production and as globally coordi-

nated effort calmed the Japanese FX market, KOSPI

recovered back to 2,107 points.

The increase in January is mainly due to global liquid-

ity condition backed by Quantitative Easing 2 (QE2) by

the Fed and to the robust outlook of emerging

Financial Markets and Industries 31

Figure ⅡⅡ.6 KOSPI and Total Trade Value

Source: Korea Stock Exchange (KSE).

Table ⅡⅡ.1 Stock Investment Flows(Unit: bil. won)

Note: 1) Including pension funds.Source: KSE.

2010 2011

1/4 2/4 3/4 4/4 1/4

Securities △325 43 434 877 605Cos.

Insurance 339 559 453 △860 △769Cos.

ITCs △2,551 △4,110 △5,607 △6,362 1,552

Banks △931 258 △165 △603 317

Other1) 710 418 1,681 △200 2,804

All △2,758 △2,832 △3,204 △7,147 1,406Institutions

Individuals 3,172 3,237 △3,425 △2,078 639

Foreign 5,930 △404 6,629 9,225 △2,045Investors

Figure ⅡⅡ.5 Dollar/Euro Exchange Rate andYen/Dollar Exchange Rate

Source: BOK.

economies. Risk appetite of foreign investors

decreased in late January, however, as evidenced by

their net selling of Korean equities, reversing the trend.

In this environment, the Japanese earthquake and the

nuclear crisis along with it appeared to further move the

index downward. But KOSPI proved more resilient

than that, though we still have to watch out for nuclear

breakout or abrupt rise in US yields after QE2.

Foreign investors purchased a net 9,225 billion won in

equities in the fourth quarter of 2010, continuing the

6,629 billion won in net buying in the previous quarter.

Foreign investors net purchased 10,579, 14,321, 5,531,

5,930, and -404 billion won in equities in the five preced-

ing quarters. On the other hand, as retail investors kept

redeeming their investments in mutual funds, ITCs trend

of net buying of 6,629 and 9,225 billion won in the two

preceding quarters. Their investment appetite shrank due

to the war in the Middle East and issue of high oil prices

in February. On the other hand, all institutions purchased

a net 1,406 billion won, as ITCs reduced their trend of

net selling of equities and other institutions net pur-

chased on a large scale. In four quarters of 2010, they net

sold 2,758, 2,382, 3,204, and 7,147 billion won. Retail

investors also net purchased equities amounting to 639

billion won in the first quarter of 2011.

KOSPI and KOSDAQ stock issuance in the first two

months of the first quarter amounted to 1,292 billion

won (monthly average), up 18% from the previous

quarter (Table II.2). Corporate financing also increased

in the quarter to 12,442 billion won, due to the increase

in both corporate securities offerings and corporate

bonds issuing.

2. Outlook for 2011

Interest Rates


Since inflationary pressures are expected to persist as

favorable economic conditions continued and interna-


Table ⅡⅡ.2 Corporate Financing(Unit: bil. won)

Note: 1) Total volume of direct financing(bonds and stocks).

2) Offerings on Korea Exchange (KRX) and KOSDAQ.

Source: Financial Supervisory Service (FSS).

2010 2011

1/4 2/4 3/4 4/4

Corporate 9,145 11,552 10,320 10,070 12,442Financing (A)1)

CorporateSecurities 922 725 708 1,092 1,292Offerings (B)2)

•Initial Public 687 213 317 218 314Offerings•Rights 235 512 391 874 978

Offerings

B/A 10.1 6.3 6.9 10.8 10.4

1/4(Jan.~Feb.)

tional commodity prices including crude oil rise, the

base rate of the Bank of Korea is expected to increase

additionally in the rest of 2011.

Therefore, market rates are expected to trend higher

during 2011. However, the increase in market rates

should be limited, since such rates factor in corporate

expectations of the BOK’s future strict monetary policy

and from high demand from financial institutions and

foreign investors.

Therefore, Treasury bond (3yr) yields and corporate bond

(AA- and 3yr) yields in 2011 are expected to be 4.0% and

4.8%. In the first half, they will be 3.8% and 4.6% and, in

the second half, they will be 4.1% and 4.9%.

Exchange Rate


In 2011, the won/dollar exchange rate is expected to

average 1,075, down from the 1,156 figure of 2010, dri-

ven by a sustained current account surplus in Korea,

foreign portfolio investment inflows and the ongoing

monetary easing policies of the Fed. However, this

downward trend of won/dollar exchange rate will be

gradual since the US dollar may strengthen after the ter-

mination of QE2 and a high oil price may reduce

Korea’s current account surplus and put a break on the

fast appreciation of won.

Stock Prices

Hyungjoon (Ray) Lim ([email protected]))

In the second quarter of 2011, Korea's equity market is

expected to have balanced upside and downside risks.

The upside risks mainly hinge on two things. First,

emerging economies would win the battle on inflation,

relieving the pressure of central banks to hike the rates

much further. Second, the commodity prices are


expected to finally decrease, also downsizing the infla-

tion risks.

Downside risks also lurk, however. Should the loss in

project financing loan spread or should the household

debt crisis emerge, the KOSPI could face considerable

downward adjustments. Plus, the pullback of foreign

investors after the QE2 cannot be ruled out, albeit

unlikely.

B. Money and Credit


In January and February, the money supply continued

to increase, but at a slower pace than the fourth quarter

2010. The average growth rate of M2, which is called

broad money, fell from 7.4% to 5.0% y.o.y. in February,

extending a downtrend begun since July 2010.

Monetary Aggregates

Between January and February, the reserve base (aver-

age) increased 13.2% y.o.y., higher than 12.5% of the

fourth quarter. This was mainly because bank notes &

coins issued increased 18.4% and foreign exchange

reserves continued to increase. In February, the y.o.y.

change in the amount of foreign exchange reserves was

$27.0 billion.

On the other hand, the outstanding of MSBs (monetary

stabilization bonds), which is used as a measure for the

BOK to control market liquidity, has decreased

slightly. It totaled 162.3 trillion won at the end of Feb-

ruary 2011, 1.2 trillion won less than the end of 2010.

Meanwhile, a monthly average issuance in MSBs

increased to 12.1 trillion won comparing the figure 10.9

trillion won of the fourth quarter 2010.

M2 growth in January and February was 5.7% (y.o.y.),

lower than the 7.4% of the fourth quarter 2010, as the


Figure ⅡⅡ.8 Monetary Stabilization BondsOutstanding

Note: 1) End of period.

Source: BOK.

Figure ⅡⅡ.7 Money Supply (average)Growth Rates

Note: Based on average money supply outstanding.

Source: BOK.

money supply from overseas decreased as the capital &

financial account deficit continued. Domestically, in

first two months of 2010, the average outstanding of

beneficial certificates decreased 7.6% y.o.y., or 11.8

trillion won, after a 13.1% decrease in the fourth quar-

ter of 2010. Also, that of CDs decreased 61.2%, or 54.2

trillion won during the periods of 2011. Meanwhile,

short-term savings deposits' average outstanding

increased 16.8%, or 112.5 trillion won y.o.y., leading

M2 growth in January and February.

Also the outstanding of demand deposits and transfer-

able savings deposits increased 7.7%, 12.7% respec-

tively in those months.

The growth of Lf (liquidity aggregates of financial

institutions, previously M3) also continued to decrease,

falling to 5.9% in January and February of 2011. The

growth has decreased since June 2010 was 8.3% in the

fourth quarter 2010. This was mainly because of the

decrease in M2's growth.

Business and Household Credit

Total depository banks’ corporate lending at the end of

the first quarter 2011 was 529.7 trillion won, which was

made up of 437 trillion won of small- and medium-

sized enterprise (SME) loans and 92 trillion won of

large enterprise (LE) loans.

In the first quarter, total depository banks' corporate

lending increased 12.6 trillion won mainly owing to

seasonal factors including the relending of loans tem-

porarily redeemed at year-end. Notably, lending to

SMEs rebound at a faster pace since January as efforts

by banks to expand their lending. LE loans also

increased 5.0 trillion won in the first quarter, but

recently it grew at a slower pace owing to LE's debt

ratio management at quarter-end.

On the other hand, household lending increased 3.0 tril-

lion won less than the 8.9 trillion won of the fourth

quarter as deficit-account loans decreased 1.7 trillion


Table ⅡⅡ.3 Q.o.Q Changes in Bank Loans

(Unit: tril. won)

Note: 1) Includes mortgage loans. 2) Monthly data is over the previous month.

Source: BOK.

2010 2011

2Q 3Q 4Q 1Q

Corporate 3.7 5.9 6.8 12.6Loans

(LEs) 2.7 4.1 0.1 5.0

(SMEs) 1.0 1.7 △6.9 7.7

Household 8.6 3.7 8.9 3.0Loans

(Mortgage1)) 5.9 3.6 7.7 4.7

won, even though mortgage loans increased 4.7 trillion

won. Despite a decline in the number of apartments to

move in to, growth in mortgage lending accelerated

slightly, mainly due to the start of the spring moving

season and to banks’ strengthened efforts to expand

loans.

Corporate direct financing increased 12.1 trillion won

in the fourth quarter of 2011, more than the 7.1 trillion

won of the fourth quarter. Specifically, corporate bond

issuance (public offering) increased 4.1 trillion won in

the quarter, driven by issuance demand in line with the

sustained upward trend of the economy and the low

cost of raising funds.

CP also showed a large net redemption. Financing

through the stock market continued to increase, particu-

larly through a paid-in capital increase and initial offer-

ings, thanks to the bullish stock market.

Beneficiary certificates at investment trust manage-

ment companies (ITMCs) declined sharply except for

stock- type and new-type deposits. Deposits in equity-

type investment funds increased 0.3 trillion won in the

first quarter. Also new-type deposits increased 1.8 tril-

lion won in the quarter. Meanwhile, bond-type and

bond-equity type deposit decreased 7.1 trillion won, 1.7

trillion won during the first quarter as the bond yields

declined.

Outlook for 2011

In 2011, the corporate and household bank lending is

expected to continue to rise with the solid growth of

real economy sector. However, its growth will be lim-

ited by a rise in the base rate.

Meanwhile, since the lending demand of households

would continue to be high with high inflation, chunsei

price (chunsei: a deposit made to the owner of the

dwelling, the leasor, as a kind of security) and so on, the

household lending is expected to show a solid growth

through 2011.


Figure ⅡⅡ.9 Beneficiary Certificates at ITMCs

Source: BOK.

Table ⅡⅡ.4 Corporate Direct Financing1)

(Unit: tril. won)

Note: 1) Excludes financial institutions.2) KOSPI and KOSDAQ.3) Based on securities companies and

merchant banking accounts at banks. 4) as of March 20.

Source: BOK.

2010 2011

2Q 3Q 4Q 1Q

Stock2.5 1.4 3.7 3.3

issuance2)

Net issuance△0.2 1.4 △4.2 4.7

of CP3)

Net issuance of3.1 △0.7 5.5 4.1

corporate bonds

Total 5.4 2.1 5.0 12.1

C. Financial Industries

1. Banking Industry

Hyoungsik Noh ([email protected])

Asset Growth

The Korean banks’ assets decreased significantly to

1,835.8 trillion won in the fourth quarter of 2010, down

2.4% from the previous quarter. Yet, this is up 2.2%

from a year ago. Accounts receivable in the banking

account decreased significantly by 36.9 trillion won,

down 68.6% from the previous quarter. Cash and due

from banks in the banking account decreased by 7.0

trillion won, and securities in the same account also

decreased by 5.2 trillion won. There was a steady

increase in the trust account during the year, however.

The growth in the trust account in the fourth quarter of

2010 was huge, which was up 5.0% from the third quar-

ter and up 9.4% from a year ago.

Total loans by Korean banks were 947.5 trillion won, a

0.2% increase from the end of the third quarter and

3.6% increase from the same quarter last year. This

slowdown in loan growth in the fourth quarter is due to

a decline in corporate loans of 1.3% offsetting an

increase in household loans of 2.1%. While large enter-

prises loans remained unchanged, loans to SMEs fell

by 6.8 trillion won, down 1.6% owing to banks’ level-

ing down of bad debts and companies’ management of

debt ratios at year-end. Household loans went up in the

fourth quarter by 8.8 trillion won, driven mainly by a

2.8% increase in housing loans, that is, of 7.8 trillion

won, from the previous quarter. This increase stemmed

from the trading volume recovery in the housing mar-

kets, and the continued low level of interest rates on

mortgage loans.

Profitability

In the fourth quarter of 2010, Korean banks achieved

2.1 trillion won in net income, a good improvement


Figure ⅡⅡ.10 Assets of Korean Banks1)

Note: 1) End of period.

Source: FSS.

(Unit: tril. won)

from last year’s figure of 1.5 trillion won. However, it

was down 0.6 trillion won over the previous quarter.

The weakening of net profits has been driven by a drop

in non-interest income and continued high level of bad

debt expenses, despite improving net interest margins

and higher net interest income.

Net interest income increased considerably to 9.7 tril-

lion won, up 6.6% from the previous quarter, thanks to

a recovery in the net interest margin.

Net interest margins rose 0.2%p over the previous quar-

ter to 2.32%, back from the drops in the two previous

quarters, but remained below the 2.40% figure from the

first quarter of 2010.

Non-interest income decreased 0.8 trillion won to 1.4

trillion won. However, non-interest income during

2010 increased 47.7% over the previous year to 7.8 tril-

lion won, reflecting a huge increase in securities-

related income growth of 72.0% amid the strong securi-

ties market.

Loan loss provisions decreased 0.9 trillion won over

the previous quarter to 2.5 trillion won. However, loan

loss provisions throughout the year increased to 14.1

trillion won from 12.1 trillion won in the previous year.

Bad debt expenses in the fourth quarter decreased to 3.2

trillion won, down 0.2 trillion won from the previous

quarter. Bad debt expenses of 14.8 trillion won in 2010

were up 13.0% from the previous year's figure of 13.1

trillion won.

Soundness and Capital Adequacy

The asset soundness of Korean banks substantially

improved as the NPL ratio eased to 1.88% after peaking

in the third quarter. This has primarily been the result of

an aggressive clean-up of bad assets by Korean banks

through the sale or write-down of bad loans. Nonethe-

less, the NPL ratio is still high compared to the one a

year ago, 1.24%. Meanwhile, the ability of domestic

banks to absorb loan losses also improved as the cover-

age ratio recovered considerably in the fourth quarter.


Table ⅡⅡ.6 Composition of Banks’ Net Income(Unit: tril. won)

Note: Net income is cumulative.Source: FSS.

10.1/4 10.2/4 10.3/4 10.4/4

Net Interest Income 9.4 9.3 9.1 9.7

Net Non-Interest Income 2.0 2.2 2.1 1.4

Table ⅡⅡ.5 Composition of Bank Loans(Unit: tril. won)

Note: Includes Korea Development Bank.Source: BOK.

09.4/4 10.1/4 10.2/4 10.3/4 10.4/4

LE 75.5 80.3 83.1 87.3 87.3

SME 430.7 434.0 434.9 436.6 429.7

Housing 265.1 267.2 273.2 276.8 284.6

Others 142.3 141.0 143.7 143.8 144.9

Figure ⅡⅡ.11 Net Interest Margin

Source: FSS.

(Unit: %)

The NPL coverage ratio ended up at 111.21% from

94.1%, which was the first sinking below 100% since

the last quarter of 2004.

The BIS capital adequacy ratio of domestic banks at the

end of the fourth quarter of 2010 was 14.60%, down by

0.02%p over the previous quarter. The tier 1 ratio also

dropped to 11.64%, down 0.11%p over the third quar-

ter. However, for the year, the increase in tier 1 capital

by 7.0 trillion won and increase in BIS capital by 1.8

trillion won combined with the decrease in risk-

weighted assets by 5.1 trillion won resulted in 0.71%p

gain in the tier 1 ratio and 0.24%p gain in the BIS capi-

tal ratio.

Outlook

Growth opportunities for Korean banks are expected to

rebound in the first half of 2011. Continuing improve-

ments in economic conditions, a leveling-down of bad

debt expenses, and competition among largest banks to

be a leading bank will offer a better environment for

growth.

In the second quarter of 2011, SME loans are expected

to grow slightly owing to banks’ efforts to expand loans.

Mortgage loans will continue to grow moderately in the

second quarter while overall household loans are

expected to grow at a much slower pace thanks to the

enhanced surveillance of household debt levels.

Korean banks’ net income is expected to continue to

improve in the second quarter of 2011. Net interest

income is expected to grow through an increase in loan

rates amid rising market interest rates. On the other hand,

net non-interest income will slow even under the strong

securities market since temporary capital gains from sell-

ing securities do not appear as probable as before and

discretionary investment service is not allowed to banks.

Net interest margins have a room for improvement from

rising rates and lowered funding costs.

The asset soundness of Korean banks of the second

quarter of 2011 is expected to ameliorate slightly. Res-


Figure ⅡⅡ.13 Growth Rate of Demand Depositand CMA

Source: FSS.

Figure ⅡⅡ.12 BIS Ratio and Sub-StandardLoan Ratio

Source: FSS.

(Unit: %)

(Unit: %)

olution of troubled real estate PF loans which is under

way will improve indicators of asset soundness. How-

ever, the default rates of loans for domestic banks are

likely to rise due to a rise in interest rates on loan. More

or less Korean banks should be able to keep asset

soundness under control as long SME loans and house-

hold loans are properly watched over.

It is expected that Korean banks will maintain good

capital adequacy level in the second quarter of 2011

through the reduction of the bad debts and the profit

improvements. However, it is necessary for Korean

banks to be alert for possible deterioration in asset

soundness and reduction in capital in turn. In case bad

debt expenses are poorly managed, net income will be

negatively affected, which will deteriorate quantity and

quality of capital. Korean banks should make efforts to

be in good shape in terms of capital adequacy and com-

position of capital.

2. Non-Banking FinancialInstitutions

Soonho Lee ([email protected])

Credit Card Companies

During the fourth quarter of 2010, the total assets of

credit card companies increased 7.1% to 54.5 trillion

won, up from 50.9 trillion won in the previous quarter

(Figure Ⅱ.14). Card assets, which comprise the largest

portion of total assets, increased by 9.3% to 35.3 trillion

won q.o.q. due to the increased credit card loans and

receivables on credit card installment sales. The out-

standing balance of loan & factoring increased from 1.0

trillion won to 1.2 trillion won. Meanwhile, lease &

installment assets stayed flat at 2.8 trillion won. A

decrease in cash and cash equivalents led to a fall in

current & fixed assets of 2.9% to 6.6 trillion won from

6.8 trillion won.

Total net income in the last quarter of 2010 soared

152.3% to 1,333.9 billion won from 528.7 billion won


Figure ⅡⅡ.14 Total Assets & Card Assets atCredit Card Companies

Source: FSS.

Figure ⅡⅡ.15 Net Income & Amortization ofCredit Losses at Credit CardCompanies

Note: Calculated quarterly.

Source: FSS.

Table ⅡⅡ.7 Financial Indicators ofCredit Card Companies

(Unit: %)

Source: FSS.

2009 2010

4Q 1Q 2Q 3Q 4Q

Adjusted29.1 28.1 30.2 30.0 28.5capital ratio

Delinquency2.2 2.0 1.8 1.8 1.7ratio

Substandard &below loans 2.0 1.7 1.5 1.4 1.3

ratio

ROA 4.3 4.5 3.8 3.8 5.5

ROE 15.8 15.3 13.4 13.4 19.8

(Unit: bil. won)

q.o.q. (Figure Ⅱ.15). This increase was due to

increased affiliates fees and revenues on credit card

loans. Samsung Card recorded net profits of 792.6 bil-

lion won as the most profitable credit card company.

This was up 504.5% from 131.1 billion won q.o.q..

Shinhan Card registered profits of 367.9 billion won

from 213.1 billion won q.o.q.. Because of the initial

marketing expenses, the net income of Hana SK Card,

which was divided from Hanabank, realized losses of

12.2 billion.

There was a decrease in the average adjusted capital

ratio, which fell from the previous quarter’s 30.0% to

28.5% (Table Ⅱ.7). Because of the increase in debt

repayment ability, the combined delinquency ratio of

credit card companies decreased in 1.7%. The substan-

dard & below loans ratio stood at 1.3%, 0.1%p lower

than in the previous quarter. Credit card companies'

ROA and ROE soared 1.7%p and 6.4%p, respectively.

This increase was due to an increase in the net income

of credit card companies.

With the recent increase in competition, credit card

companies need to keep their existing customers and

acquire new customers with aggressive marketing.

Thus, the increased cost of sales will continue for the

time being.

Credit Finance Companies Other thanCredit Card Companies

Owing to the domestic consumption expenditures

recovery in the last quarter of 2010, total assets of credit

finance companies increased 4.6% to 66.3 trillion won

from 63.4 trillion won in the preceding quarter (Table

Ⅱ.8). The total assets of leasing companies and install-

ment financing companies grew 3.3% to 25.2 trillion

won and 5.2% to 36.3 trillion won, respectively. The

total assets of venture capital companies increased by

6.7% to 4.8 trillion won due to a growth of loans and

securities investment. Total durables installment assets

in credit finance companies increased by 13.0% to 8.1

trillion won (Figure Ⅱ.16). Despite the termination of

tax incentives for new car purchases, an increase in the


Figure ⅡⅡ.16 Assets at Credit FinanceCompanies (Excluding CreditCard Companies)

Source: FSS.

Table ⅡⅡ.8 Total Assets at Credit FinanceCompanies (Excluding Credit CardCompanies)

(Unit: tril. won)

Source: FSS.

2009 2010

4Q 1Q 2Q 3Q 4Q

Leasing 22.5 22.5 23.4 24.4 25.2companies

Installmentfinance 32.9 33.1 33.6 34.5 36.3

companies

Venturecapital 4.2 4.9 4.3 4.5 4.8

companies

Total 59.6 60.5 61.3 63.4 66.3

(Unit: bil. won)

new car purchases was the main factor behind the

durables installment assets growth. The decrease in the

buying of foreign cars reduced operating lease assets,

which were down 0.9% to 7.2 trillion won (Figure

Ⅱ.16). As housing trading increased from 230 thousand

households to 340 thousand households, new house

installment assets were increased. The house install-

ment assets increased by 3.8%, at 1.0 trillion won.

The net income of credit finance companies was 163.8

billion won, a q.o.q. decrease of 22.0% from 209.9 bil-

lion won (Table Ⅱ.9). Operating revenue and expenses

indicated 2,347 billion won and 2,104 billion won,

respectively, and therefore operating profit was at 244

billion won. The total net income of installment compa-

nies went up 57.8 billion won from 198.0 billion won,

while leasing companies turned around 75.1 billion

won from a deficit of 12.9 billion won.

Owing to net income surplus, excluding installment

financing companies, the ROA of most credit finance

companies increased. Meanwhile, most credit finance

companies saw an improvement in loan soundness in

the quarter. The loan loss reserve ratio and substandard

& below loans ratio of installment financing companies

both deteriorated. Meanwhile, the capital adequacy

ratio of credit finance companies slightly decreased.

Thus, paid-in capital increase for capital soundness will

be required.

The increasing competitive pressure from newly-enter-

ing credit finance companies will increase operating

costs. Due to the insolvency risk of project financing

loans, persistent risk management will be needed.

Mutual Savings Banks (MSBs)

In the first half of FY2010 (2010.7.1~12.31), the

increased available-for-sale securities led the growth of

total assets although the allowance for credit losses for

project financing loans was largely increased. Because

of the increase in cash and non-business purpose prop-

erties, the total assets of MSBs increased also. The total

assets of MSBs rose 0.5% to stand at 86.9 trillion won.


Table ⅡⅡ.9 Financial Indicators of CreditFinance Companies (Except CreditCard Companies)

(Unit: bil. won, %)

Note: Net income is calculated quarterly. Source: FSS.

2010

1Q 2Q 3Q 4Q

Lease △99.8 91.0 △12.9 75.1Installment 213.6 184.2 198.0 57.8

Venture92.4 △61.7 24.8 30.9capital

Total 206.2 213.5 209.9 163.8Lease 1.7 1.3 0.7 0.8

Installment 1.9 2.0 2.1 1.9Venture

3.0 3.1 1.8 2.1capital

Lease 108.3 82.5 74.7 77.5Installment 104.1 107.1 99.9 93.6

Venture69.1 62.0 52.9 70.2capital





Loanloss

reserveratio

Sub-standard& below

loansratio

Adjustedcapitalratio

Netincome

ROA

The deposits of MSBs expanded by 0.5% to register

76.8 trillion won, while and loans increased 3.5%,

recording 64.6 trillion won for this period (Figure

Ⅱ.16). The proportion of loans has steadily increased.

As the burden of allowance for credit losses for project

financing loans will be increased, the ratio of total

assets growth is expected to shrink.

During the first half of 2010, the net income of MSBs

recorded to a deficit of 556.2 billion won, which was

brought on by the accumulated commission fees and

other operating expenses. In particular, four of the top

10 MSBs based on assets recorded a deficit. As the net

income of MSBs indicated a deficit, the ROA, an index

of profitability, recorded -0.6%. In addition, the ratio of

substandard & below loans, which shows assets sound-

ness of MSBs, worsened slightly from 10.3% to 10.6%

over the first half of FY2010. This deterioration was

due to project financing loan losses. Meanwhile,

despite an increase in risk-weighted assets, BIS capital

adequacy ratio of MSBs kept the same level at to 9.1 as

MSBs increased their capital by issuing stocks.

In the second half of FY2010, due to strengthened reg-

ulatory standards by the Financial Supervisory Service

(FSS) on PF loans and additional reserve of loan loss

provision, MSBs will be expected to increase the pro-

portion of retail banking including personal credit loans

rather than real estate-related loans. MSBs will need to

enhance their asset risk management to strengthen

assets soundness. Owing to the increased substandard

& below loans ratio, measures such as a selling of insol-

vent loans will be needed. In addition, because of the

declining trend in BIS capital ratio, MSBs will have to

extend their capital through a paid-in capital increase

and a dividend decrease. Deposit of MSBs will con-

tinue to increase because of the high interest rate.

Mutual Credits (MCs)

This category includes agricultural cooperatives (ACs),

fisheries cooperatives (FICs), forestry cooperatives

(FOCs) and credit unions (CUs). During the forth quar-

ter of 2010, the total assets of mutual credit institutions


Table ⅡⅡ.10 Financial Indicators of MSBs (Unit: bil. won, %)

Note: Net income is calculated biannually. Source: FSS.

2008.12 2009.6 2009.12 2010.6 2010.12

Net Income 98.4 △105.1 134.3 △951.9 △566.2

ROA 0.2 0.1 0.2 △0.9 △0.6

BIS Capital Ratio

9.3 9.6 9.3 9.1 9.1

Substandard& Below 9.1 9.7 9.3 10.3 10.6

Loans Ratio

Figure ⅡⅡ.17 Total Assets, Deposits & Loansat MSBs

Source: FSS.

(MCs) increased slightly by 3.5% q.o.q. to stand at

310.5 trillion won (Table Ⅱ.11). Total deposits rose by

3.1% to 254.3 trillion won from 246.6 trillion won.

Because of the increased tax-free savings limits and

high deposit rates, the upward trend in deposits contin-

ued over time. Total credits rose about 2.0% from 181.3

trillion won to 184.9 trillion won. Since deposits

increase more rapidly than loans, the ratio of credits to

deposits declined over the fourth quarter of 2010.

Despite the increased operating revenues from loans

for the ordinary people, the mutual credit institutions

registered negative net income (Table Ⅱ.12). Also, the

high financing costs from the high deposit interest rate

raised operating expenses. The total combined net

income of MCs was a deficit of 151.6 billion won in the

last quarter of 2010. CUs, FICs and FOCs registered a

net income of 37.7 billion won, 39.6 billion won, and

12.4 billion won, respectively, while ACs recorded a

deficit of 241.3 billion won.

The ROAs of CUs and ACs declined slightly to 0.1%p

and 0.4%p, respectively. The ROA of FICs increased to

0.7% from 0.6%, while that of FOCs stood at the same

level of 1.1%. MCs faced developed loan soundness,

compared with the previous quarter. The delinquency

ratio of CUs, ACs, FICs and FOCs went down 0.8%p to

6.5%, 0.7%p to 3.1%, 1.1%p to 5.6%, and 1.4%p to

6.3%, respectively. This betterment was due to the

enhanced household income of the ordinary people

who that are the main customers of the MCs. Due to the

writing-off of year-end bad debts, most MCs’s substan-

dard & below loans ratios decreased considerably,

while that of FICs maintained the same level. In all

areas, MCs’s loan loss reserve ratio increased. Because

of the capital raising, the net capital ratio of ACs and

FICs improved slightly.

Due to seasonal effects like farming season, the demands

for of new policy lending and small loans will increase

consistently. So MCs’ asset growth and profitability will

improve. However, due to the rising interest rate on

home loans, there is a potential insolvency risk, meaning

they should strengthen their risk management.


Table ⅡⅡ.11 Total Assets & Ratio of Credits toDeposits at Mutual Credits

(Unit: tril. won, %)

Source: FSS.

2009 2010

4Q 1Q 2Q 3Q 4Q

Total Assets 281.2 285.7 294.5 300.1 310.5

Credits 173.8 174.7 178.0 181.3 184.9

Deposits 227.8 234.2 242.2 246.6 254.3Ratio of Credits

76.3 74.6 73.5 73.5 72.7to Deposits

Table ⅡⅡ.12 Financial Indicators of MutualCredits

(Unit: bil. won, %)

Notes: 1) Loan-loss reserve ratio is the ratio of reserved allowances for the credit losses of mutual credits relative to the minimum required allowances for the credit losses.

2) Net income is calculated quarterly.Source: FSS.

2010

1Q 2Q 3Q 4Q

Credit Unions 90.2 97.2 112.3 37.7

Agricultural 742.9 557.1 437.4△241.3

Fisheries 10.7 41.7 15.8 39.6

Forestry △9.5 34.0 9.3 12.4

Total 834.3 730.0 574.8 △151.6

Credit Unions 0.9 0.9 0.9 0.8

Agricultural 1.3 1.2 1.0 0.6

Fisheries 0.3 0.7 0.6 0.7

Forestry △1.0 1.2 1.1 1.1



Fisheries 6.7 6.6 6.7 5.6

Forestry 7.9 7.4 7.7 6.3



Fisheries 3.5 3.5 2.0 2.0

Forestry 3.2 3.2 3.7 3.3

Credit Unions 104.5 104.0 103.8 106.2

Agricultural 163.4 165.6 163.0 180.9

Fisheries 129.5 127.2 122.1 129.6

Forestry 106.4 114.6 110.8 112.7



Fisheries 1.7 2.0 2.2 2.4

Forestry 10.8 10.9 11.3 11.3

Delinquencyratio

Standard& below

loansratio

Loan-lossreserve

ratio

Net capitalratio

Netincome

ROA

3. Securities Industry

Junghan Koo ([email protected])

Assets

The assets of securities companies increased 21.9% to

199.8 trillion won during the fourth quarter of 2010, up

from 164 trillion won in the same quarter last year (Fig-

ure Ⅱ.18). This was attributable to the increase in mar-

ketable securities, especially in bond holdings, which

were up 20.7 trillion won. There was also an increase in

broker’s loans of 5.1 trillion won as well as in cash and

deposits of 6.8 trillion won. Total stockholder’s equity

increased 8.1% to 37.2 trillion won from 34.4 trillion

won over the same period. This is mainly due to the

increase of retained earnings by 1.8 trillion won.

The ratio of securities companies’ asset size to com-

mercial banks’ asset size increased 2.9%p, up from

14.6% in the same quarter of last year. The asset size of

securities companies increased more significantly than

that of commercial banks. However, the HHI index

(market concentration index) of securities companies

was only 312, indicating that big securities companies

did not comprise a large market share.

Profitability

During the fourth quarter, securities companies’ profits

increased 188.9% over the same period last year to 780

billion won (Figure Ⅱ.19), driven by increased broker-

age commissions and fees from asset management ser-

vice. Brokerage commissions went up due to the

increased transaction volumes over the same period. In

addition, some securities companies got unexpected

earnings. However, profits from bond holdings

decreased by 764 billion won compared to the third

quarter of 2010 as interest rates went up from Novem-

ber 2010.


Figure ⅡⅡ.19 Profits of Securities Companies

Source: FSS.

Figure ⅡⅡ.18 Total Assets of SecuritiesCompanies

Source: FSS.

(Unit: tril. won)

(Unit: bil. won)

Capital Adequacy

The net capital ratio (net capital over total risk, and

indicator of the capital adequacy of securities compa-

nies) fell 37%p from 576% to 539% at the end of the

fourth quarter of 2010 (Figure Ⅱ.20). Despite higher

net operating capital, total risk rose due to the higher

exposure to interest rate risk. The expansion of bond

holdings raised interest rate risk of securities compa-

nies. Although net operating capital went up 11.6%

from 26.4 trillion won as of December 2009 to 29.4 tril-

lion won as of December 2010, total risk amount also

rose 19.2% from 4.6 trillion won to 5.5 trillion won

over the same period.

Outlook

In the second quarter of 2011, the assets of securities

companies are projected to increase. The stock market

is expected to rise because there are not many invest-

ment targets due to sluggish real estate market. Espe-

cially, current inflation rate will make secure assets

such as deposits less attractive to investors. Hence,

money inflow toward risky assets such as stocks and

bonds is expected. The current expansion of asset man-

agement market and retirement pension market will

expand the asset size of securities companies.

Profitability is expected to rise as brokerage commis-

sions will rise due to the rising transaction volumes. In

addition, many investors are hard to find appropriate

investment vehicle. Hence, profits from asset manage-

ment-related service, such as selling wrap accounts and

funds, are expected to rise.

Capital adequacy is likely to remain on the same level.

The increase of profits will push net operating capital

up, but total risk is likely to rise at the same rate. Since

the net capital ratio is well above the FSC’s recom-

mended level of 150%, the capital adequacy of securi-

ties companies will not be an issue in the future.


Table ⅡⅡ.13 Total Value of Stock Trading &Commission Income

(Unit: tril. won)

Source: FSS, KRX.

09.4Q(10~12) 10.4Q(10~12)

Total Value of Trading 302 415

Commission Income 1.72 2.22

Figure ⅡⅡ.20 Net Capital Ratio of SecuritiesCompanies

Source: FSS.

(Unit: %)

4. Insurance Industry

Sukho Lee ([email protected])

Life Insurance

At the end of the third quarter of FY2010, life insurance

industry assets totaled 408.5 trillion won, a 2.7%

increase over the previous quarter. Premium income

was 23.3 trillion won, up 4.3% y.o.y. mainly from an

increase of endowment insurance and variable life

insurance thanks to economic recovery and steady

stock market rally. This upward growth trend seems to

continue during the fourth quarter of FY2010 due to a

major improvement in the investment environment.

Meanwhile, total claims paid by life insurers increased

18.7% y.o.y. to 16.5 billion won (Table Ⅱ.14).

The respective percentages of premium income from

death insurance, pure endowment insurance, endow-

ment insurance, and group insurance were 49.5%,

30.3%, 18.8%, and 1.4% (Figure Ⅱ.21). The share of

death insurance and group insurance decreased 3.6%p

and 0.2%p, respectively, while the share of endowment

insurance and pure endowment increased 3.3%p and

0.5%p, y.o.y. The share of premium income from

endowment insurance increased, due to its relative

competitiveness in interest rate under continuation of

low market interest rate trend and an increase in sales

through bancassurance channels. The increase in the

share of premium income of pure endowment insur-

ance occurred mainly from greater demand for after-

retirement related insurance products and preparation

for elderly life products due to the rapid aging of the

population. Meanwhile, the proportion of total pre-

mium income from death insurance declined slightly

due to a decreased demand for whole life insurance

despite an increased demand for illness insurance.

As shown in Figure Ⅱ.22, the top three life insurers still

dominate the market (52.8%), though their market

share did drop 2.1%p y.o.y due to decreasing premium

of the their major insurance products such as death

insurance and group insurance.


Figure ⅡⅡ.21 Premium Breakdown of LifeInsurance Industry

Note: End of December 2010.

Sources: FSS, KLIA, KIF.

TableⅡⅡ.14 Life Insurance Industry Indicators1)

(Units: bil. won, %)

FY2009 FY2010

4Q 1Q 2Q 3Q

Total 372,525 381,662 379,611 408,495Assets2) (3.1) (2.5) (4.2) (2.7)

New 92,127 79,241 86,014 87,447Contracts (△12.9) (△16.1) (△14.9) (△15.0)

Policies in 1,731,603 1,733,765 1,747,068 1,767,217Force2) (0.3) (0.1) (0.8) (1.2)

Premium 19,142 19,240 19,237 23,320Income (8.6) (9.8) (7.2) (4.3)

Claims12,587 11,306 11,201 16,480(1.3) (11.2) (4.2) (18.7)

Expenses1,394 1,434 1,319 1,306(16.2) (14.9) (8.0) (△3.7)

17.3 16.7 16.3 16.2

50.9 51.7 52.1 52.4

2.6 2.7 2.8 3.0

3.2 3.1 3.0 3.0

26.1 25.7 25.7 25.4

Notes: 1) Figures in parentheses and brackets undertotal assets & policies in force represent per-centage changes from the previous quarterand previous month, respectively. All othersare year-on-year changes.

2) End of period.Sources: FSS, Korea Life Insurance Association (KLIA),

KIF.

LoansSecurities

Cash & Dep.Real-Estate

Other

(Unit: %)

The market share of small & medium-sized life insurers

increased by 2.5%p thanks to an increase in sales of

savings type products mainly through new sales chan-

nels such as bancassurance, homeshopping, online

channel, etc. Meanwhile, the market share of foreign

life insurers was down 0.5%p. It is demanded that for-

eign life insurers should diversify their sales channels

more rather than depending too much on bancassurance

channel.

As of the end of December 2010 life insurance industry

operating profits totaled 21.4 trillion won, up 32.9%

over the same period last year. Underwriting profits

increased 65.5% y.o.y. to 9.4 trillion won, while invest-

ment profits saw a 15.2% y.o.y. rise to 12.0 trillion won.

The growth in underwriting profits occurred mainly

due to an increase of 5.5% in operating revenue and a

fall of 4.0% in operating cost y.o.y. On the investment

side, an increase in profits resulted mainly from both

improvement in the investment environment and life

insurers' efficient investment operations. The growth in

investment profit occurred thanks to a sharp fall

(39.1%) in investment cost. Net profits of life insurers

at the end of December of 2010 were 3.1 trillion won, a

42.9% increase y.o.y..

Non-Life Insurance

As of the end of December 2010, non-life insurance

industry assets totaled 99.0 trillion won, a 4.8%

increase over the end of the previous quarter. This was

attributable to growth in investment income from an

upturn in the overall investment environment and con-

tinued growth in long-term non-life insurance. Direct

premiums written in third quarter of FY2010 were up

28.6% y.o.y. to 12.8 trillion won following continued

growth of long-term non-life insurance sales by virtue

of steadily increasing demand for retirement-related

insurance products, and recovery of sales of automobile

insurance (Table Ⅱ.15). Total claims paid by non-life

insurers increased 27.3% y.o.y. to 5,870 billion won.

Meanwhile, total management expenses increased

24.1% y.o.y. to 2,640 billion won.


Figure ⅡⅡ.22 Market Share of Life InsuranceIndustry

Note: End of December, 2010.Sources: FSS, KLIA, KIF.

Figure ⅡⅡ.23 Business Performance of LifeInsurance Industry

Note: End of December, 2010.

Sources: FSS, KLIA, KIF.

(Unit: Billion KRW)

(Unit: %)

As shown in Figure Ⅱ.25, long-term non-life insur-

ance, automobile insurance, special type insurance,

individual pension insurance, guarantee insurance,

marine insurance, and fire insurance accounted for,

respectively, 56.9%, 25.1%, 8.3%, 4.9%, 2.6%, 1.6%,

and 0.5% of total premiums. The share of long-term

non-life insurance increased 2.3%p over the same

period last year thanks to their strong growth by virtue

of steadily increasing demand for retirement-related

insurance products and savings-type insurance prod-

ucts under low interest rate trend. The share of automo-

bile insurance decreased 1.9%p, although its written

premiums grew y.o.y., owing to stronger increase in

sales of long-tern non-life insurance. The proportion of

individual pension insurance increased 0.8%p thanks to

increase of the income tax deduction benefit from three

million won to four million won and continuous inter-

est in financial products for elderly-life.

As of the end of December 2010, top five non-life

insurers had a combined 76.7% share of the entire mar-

ket. Small & medium-sized non-life insurers held

20.7% and foreign non-life insurers held 2.5%, respec-

tively. While the market share of the small & medium-

sized and foreign non-life insurers decreased 0.4%p

and 0.3%p, respectively, the share of top five non-life

insurers increased 0.6%p, mainly on the strength in the

area of long-term non-life insurance and pension insur-

ance. In particular, the market share of online automo-

bile insurers among small & medium-sized non-life

insurers, was decreased due to deepening price compe-

tition in the area of automobile insurance.

At the end of December 2010, non-life insurers' total

operating profits amounted to 1,100.6 billion won, a

13.8% decrease over the same period last year. Net

profits at the end of December 2010 were 734.6 billion

won, down 17.5% from the same period last year. The

underwriting business still shows a 1,372.6 billion won

deficit in spite of growth in long-term non-life insur-

ance sales, driven by continuously increasing claims

payment owing to high loss ratio of automobile insur-

ance. Meanwhile, investment profits as the end of third

quarter FY2010 were 2,473.2 billion won, 22.1%


Figure ⅡⅡ.24 Premium Breakdown of Non-LifeInsurance Industry

Note: End of December 2010.Source: FSS, KNIA, KIF.

(Unit: %)

TableⅡⅡ.15 Key Indicators for the Non-lifeInsurance Industry

(Units: bil. won, %)

FY2009 FY2010

4Q 1Q 2Q 3Q

Total 86,163 90,253 94,449 98,987Assets (3.8) (1.4) (4.6) (4.8)

Direct Premiums

11,962 11,749 12,101 12,751

Written (29.1) (19.0) (16.3) (28.6)

Direct 5,460 4,206 5,211 5,870Claims Paid (22.3) (△6.0) (9.6) (27.3)

Management 2,648 2,436 2,602 2,640Expenses (2.5) (4.4) (3.5) (24.1)

50.9 51.3 51.9 52.3

17.8 17.4 17.3 17.5

4.9 5.1 5.3 4.9

5.9 5.7 5.7 5.6

20.5 20.4 19.9 19.7

Notes: 1) Figures in brackets under total assets repre-sent the percentage changes from the previ-ous quarter. All others are y.o.y. changes.

2) Mostly accounts receivable.Source: FSS, Korea Non-Life Insurance Association

(KNIA), KIF.

Securities Loans Cash &

DepositsReal Estate

Other2)

increase over the same period last year due to an

increase in operating assets and improvement in finan-

cial market environments.

Outlook

Total assets and premium income of the life insurance

industry in the first quarter of FY2011 are expected to

grow due to an upturn in sales of variable life insurance

and continued inflow in premium income from savings

type insurance. Meanwhile, for variable life insurance,

the life insurers need to consider a possibility of

increasing volatility of stock prices, which is critical

aspect in sales of variable life insurance. The growth of

pension insurance should be continued thanks to on-

going or expected deregulation related to pension

insurance products. In addition, endowment insurance

is expected to maintain the growth trend as well. While

competition in the area of retirement pension is

expected to become fiercer than ever before, life insur-

ers should not rush into reckless external expansion

competition.

The surrender & lapse rate of life insurance contract

seems to be gradually stable, and the contract retention

rate is also expected to improve alongside the economic

recovery. The performance of investment business is

expected to improve more as the financial market envi-

ronment continues to stabilize. In addition, interest

gains on interest-related assets of life insurers are

expected to increase as market interest rate is forecast

to rise. However, life insurers should be alert to the pos-

sibility of an appraisal loss in stocks & bonds and a rise

in loan delinquency as interest rate goes up.

During the first quarter of FY2011, non-life insurance

companies are expected to continue the growing trend.

In particular, long-term non-life insurance sales should

continue to grow thanks to steadily increasing demand

for retirement-related insurance products. However,

non-life insurers should alert and control loss ratio of

long-term non-life insurance, which has been showing

somewhat increasing trend since the second half of the

year 2009. For automobile insurance, while improve-


Figure ⅡⅡ.25 Market Share of Non-LifeInsurance Industry


(Unit: %)

Figure ⅡⅡ.26 Business Performance of Non-Life Insurance Industry


(Unit: Billion KRW)

ment in sales performance during the first quarter of

2011 is expected, there exist some negative factors such

as difficulty in additional rise of premium rate, increas-

ing uncertainty in domestic & global economic envi-

ronments, and a growing price competition. The loss

ratio of automobile insurance is expected to decrease

thanks to a rise in premium rate and a decrease in oper-

ation of an automobile due to rising oil prices. On the

investment business side, non-life insurers are expected

to see more improved returns from the better invest-

ment environment and stable asset management. In

addition, non-life insurers, like life insurers, are

expected to benefit from rising market interest rate.

Meanwhile, it is expected that the recent huge earth-

quake in Japan will have only minimal impact in

Korean insurance industry. However, an increase in

reinsurance premium rate for the time being in future

should be unavoidable the entire reinisurance market

globally.



A. Korea's Credit Card System& Potential Measures

Jae-Youn Lee ([email protected])

1. Introduction

Korea’s credit card market (including debit cards) took

off following the 1998 currency crisis, buoyed by gov-

ernment policies designed to spur consumption and

make taxable income more transparent. The govern-

ment introduced income deductions to individuals for

credit card use, and required merchants to become

credit card merchant members and accept card pay-

ments.

Korea’s payment card settlements as a share of private

consumption (goods and services purchases) was just

23.6% in 2000, but with the implementation of these

policies designed to stimulate credit card use, this fig-

ure rose sharply, reaching and 65.4% by the end of

2010. Korea’s credit card usage as a share of GDP was

36.2% as of the end of 2009, sharply higher than that of

other countries such as the US (13.7%) and Canada

(18.9%), but the same figure for direct payment and

check card usage was just 3.4%, below that of the US

(10.3%) and Canada (11.2%).

However, while growth and competition in the credit

card market led to an expansion in benefits for card user

members, the costs of these benefits have been exces-

sively passed on to merchant members, sparking com-

plaints especially from small merchants.

This paper shall examine the issues facing the Korean

credit card market by comparing two different types of

credit card systems to explore measures for resolving

the persistent dissatisfaction among merchant mem-

bers, despite merchant fees being lowered multiple

times since 2007.

Ⅲ. Current Issues 3

Table ⅢⅢ.1 Credit & Debit Card Use/PrivateConsumption

(Unit: 100 billion won, %)

Note: 1) Excludes cash service and corporate purchas-ing cards.

Source: Credit Finance Association (CFA), BOK.

2000 2001 2003 2005 2007 2008 2009 2010

CreditCards 778.7 1,342.3 1,705.3 1,904.7 2,410.8 2,793.1 3,039.4 3,506.9(A)1)

DebitCards 1.1 1.0 0.6 79.5 189.1 268.6 365.1 518.2

(B)

Private Consu 3,303.8 3,642.5 4,200.9 4,654.3 5,302.6 5,616.2 5,759.7 6,154.0mption

(C)

(A+B)/C 23.6 36.9 40.6 42.6 49.0 54.5 59.1 65.4

Table ⅢⅢ.2 Credit & Debit Card Use/GDP in2009

(Unit: %)

Note: 1) 2008 dataSource: The Bank for International Settlements (BIS),

BOK.

Korea US UK CanadaGerm Switzer

Japanany land

Credit Cards

36.2 13.7 7.7 18.9 0.5 4.9 8.41)

DebitCards

3.4 10.3 19.8 11.2 4.8 10.3 0.2

2. Problems with the transactionScheme in Korean Credit Cards

1) Problems with the Credit Card Market

In Korea, a highly competitive market structure has

formed to attract credit card user members. As of the

end of March 2011, there are 9 credit card networks and

21 issuers, and the number of credit cards held is at 4.5

cards per member of the economically active popula-

tion. This means that the credit card market is saturated.

As a result, credit card companies including banks offer

customers points, mileage, discount services, no-inter-

est installment services and annual fee exemptions in

order to entice them to use their cards.

Nevertheless, In under the market structure thus far

formed, there is almost no need to compete for mer-

chant members. Since the government policy makes it

effectively mandatory for merchants to be card mem-

bers and accept card payments, credit card companies

have a little need to compete for merchant members.

With such a market structure in place, smaller merchant

members have complained that credit card companies

pass on most of the expenses for syste ms maintenance

and marketing to the card user offering added members

on to them by maintaining high merchant fees.

Credit card companies hold greater bargaining power

over prices with most smaller merchants, but low

power with larger ones. Thus, large marts' merchant

fees are from 0.5%~1.5%, much lower than the average

fees (2.33% in 2006) because of the competition among

card companies. This lowers the card companies'

capacity to bring down smaller merchants fees.

2) Pros and Cons of Korea’s 3-Party Scheme

Under the 3-party scheme, individual credit card com-

panies recruit members and issue cards, but having to

separately recruit merchants entails high expenses on

merchant recruiting and management.

53Current Issues

Table ⅢⅢ.3 Credit Card Companies in Korea

Number Company Name

Bank BC, Shinhan, KDB subsidiary 4 Capital, Hana SK, KB,

Non-bank 3 Samsung, Hyundai, Lottesubsidiary

KEB Card 1 KEB

NACCP 1 NACCP

Shinhan Card and 4 Shinhan, Cheju, Suhyup,

alliance Chonbuk, Kwangju

IBK, KB, NACCP, Cheil, BC Card 11 Hana, Woori, Daegu, Members Busan, Kyongnam,

Citi Korea, Shinhan

Credit CardCompany

Card IssuingBank


As of the end of 2010, each of 9 credit card networks

had agreed on merchant contracts with around 2.9 mil-

lion merchants, and while 500,000 of these merchants

close their doors annually, 500,000 new contracts are

also agreed to.

Conversely, under the 4-party scheme, credit card com-

panies handle issuance and acquisition separately, so

issuers can issue joint brand credit cards, and acquirers

can jointly use the recruited merchant members. Hence,

while it is very hard for new credit card companies to

enter under the 3-party scheme, it is easier under the 4-

party scheme.

Under the 3-party scheme, since merchants are only

able to ask for acquisition of transactions to the relevant

credit card company, they have low bargaining power

in the determining of the merchant fees, that is, the cost

of processing credit card transactions. It is in reality

obligatory for merchants to join and accept credit card

payment, and since the relevant card companies can

pay for the goods in place of the customer, these com-

panies hold the power to determine the merchant fees.

Conversely, under the 4-party scheme, merchants can

choose the acquiring bank that acquires transactions, so

they can choose one that offers them better terms.

Under the 3-party scheme, since card companies can

impose most of the transaction costs on merchants, they

compete by trying to entice customers to use their cards

through offering services such as points, mileage, dis-

counts, and no-interest installment plans based on

usage amount.

But under the 4-party scheme, network companies like

Visa and MasterCard set the interchange fees that deter-

mine merchant fees, so they can control to some extent

the marketing expense of card issuers on behalf of cus-

tomers.

Figure ⅢⅢ.2 Settlement Flow Chart in a 4-Party Scheme

Figure ⅢⅢ.1 Settlement Flow Chart in a 3-Party Scheme

3. Mandating a Merchant MemberPool System

Introducing a 4-party scheme by consolidating the nine

card networks into one or two networks and switching

existing card companies to issuers would help ease prob-

lems for merchant members. Merchant members would

be able to seek out and transact with acquirers that offer

them more favorable terms and lower merchant fees.

However, each card company possesses around 2 mil-

lion merchant members, so it will not be easy to have

them give up their merchant members and switch to

being issuers.

Thus for the card companies, mandating a merchant

member pool system can help improve bargaining

power over large merchants. Since large merchants

would have to accept all credit cards regardless of

whether they are their merchant member or not and an

industry-specific interchange fee would be applied, card

companies would be able to decline requests by large

merchants for an excessive lowering of merchant fees.

However, currently, virtually all merchant members fear

being put at a disadvantage and hence sign individual

contracts with credit card companies, so there is almost

no use of a compulsive merchant member pool system.

Under the current merchant member pool system,

acquiring transactions from affiliated merchant members

are handled electronically, with payment taking 1-3 days,

but acquiring transactions from non-affiliated merchant

members are handled manually and this has the disad-

vantage of taking 6 days or more to settle the payment.

Therefore, it is necessary to stimulate the use of the

merchant member pool system by removing such

inconveniences such as time lags when disbursing pay-

ment for non-contracted credit card receipts.

The merchant member pool system may allow us to

enjoy the benefits of the 4-party scheme while main-

taining the current 3-party scheme.

55Current Issues


B. The Role of Private Financein Helping Korean FirmsWin Overseas Projects

Jeong Ho Suh ([email protected])

1. Introduction

2010 was a landmark year for Korea in terms of plant

construction. Overseas plant construction orders

totaled a record 64.5 billion USD, up 39.3% y.o.y..

As a knowledge-intensive industry, the plant industry

allows moving beyond the limitations of focusing on

manufacturing exports and also contributes to exports

to importing countries. Thus, such projects face few

trade conflicts or import restrictions and show 50-60%

rates of foreign exchange earnings. Further, since they

relate to many up- and downstream industries (steel,

machinery, power, construction, finance, law, consult-

ing, etc.), the production inducement effect of such pro-

jects is estimated to be 1.6 times that of manufacturing

and 2.4 times that of services. Moreover, as resource-

rich countries embark on a flurry of infrastructure and

resource development investment amid high oil prices

after the global financial crisis, these markets should

see explosive growth for quite some time1).

However, the problem is that a builder’s ability to raise

financing is essential to winning large orders. In short,

we are up against a reality in which financial competi-

tiveness determines industrial competitiveness. Korea

increasingly must therefore enhance the role of private

financial companies, in addition to bolstering the func-

tions of export credit agencies (ECAs)2).

This paper will look at the limiting factors of Korea’s

financial industry in fulfilling major long-term FX

Figure ⅢⅢ.3 Overseas Plant Orders

Source: Korea Ministry of Knowledge Economy.

(Unit : mil $)

1) From 'Competitive Strategy for the Plant Industry' (Ministry ofKnowledge Economy, Aug. 2004 (in Korean)), ADL estimates,Global Insight report, etc.

2) Korea has two government-established institutions for providingloans/insurance to stimulate exports: Korea Export-Import Bank(KEXIM) and Korea Trade Insurance Corporation (K-SURE).

funding demand to support plant exports, and discuss

ways of enhancing the role of private finance.

2. The Role of ECAs

Although government subsidies for export firms are

strictly limited under the WTO, public credit provided

by ECAs is usually exempted from regulation. As a

result, ECAs provide both capital for special purpose

vehicles (SPVs), as well as direct loans and external

debt guarantees (insurance) for participating firms, as

well as loans for suppliers.

For this reason, it is quite natural for another country’s

ECA to take the lead role for large-scale offshore rig

projects, while competition among countries to expand

financing for their local companies’ overseas invest-

ment and resource development is fierce. Recently,

Japan dramatically raised the amount of overseas

investment limit approved for the Japan Bank for

International Cooperation (JBIC) in order to secure sta-

ble energy and mineral resources. Further, in December

2010, it was reported that the ruling Democratic Party

of Japan considered separating the JBIC from its affili-

ated Japan Finance Corporation (JFC) and carrying out

measures to extend JBIC’s funding from mainly devel-

oping country projects to advanced nation projects as

well. That is, given that countries’ ECAs are involved

in everything from the structuring of and supply of

funding for major projects to building broad coopera-

tive ties with governments and helping win orders,

strengthening the functions of Korea’s ECAs is thought

of as an urgent task. At the same time, the role of pri-

vate financial companies is becoming more important

in regards to project financing.

3. Incubating Private Finance:Necessity & Limitations

The reason that private financial companies’ role is

becoming more critical is firstly that ECAs are not able

to provide unlimited financial support to exporters or

57Current Issues

Figure ⅢⅢ.4 A Typical Structure of ProjectFinancing for Overseas PlantExports

Source: Japan Bank for International Cooperation (JBIC).

other financial companies. With government funding

support limited, this necessarily constrains how much

FX funding can be borrowed. As a result, the need to

foster the private financial sector, such as commercial

banks and pension funds, has naturally been emerging.

Secondly, private financial companies serve as stronger

drivers than ECAs in terms of the efficient allocation

and administering of capital. With an active profit

motive, they are likely to outperform ECAs in terms of

structuring projects, follow-up, and risk assessment.

For these reasons, ECAs in advanced economies are

strictly limited to a complementary function for market

failures that avoids competition with the private finan-

cial sector.

2009 project financing figures reveal that French and

Japanese commercial banks held the top positions,

while Korean banks’ performance was relatively poor.

Why have Korean financial companies been unable to

show competitiveness in mid-/long-term export finance

such as plant export financing?

Firstly, private financial companies’ participation may

not be all that profitable. Many project contractees had

higher credit ratings than Korean financial companies,

making for low expected returns versus financing costs.

Further, for private sector participation, average total

project financing costs were higher, which increased

the chances that it would separate it from the bidding

competition.

Secondly, Korean financial companies are not adept at

long-term financing. Normally, large-scale plant con-

struction projects take over 10 years, while financing

FX funds for durations of over 10 years at competitive

interest rates is quite difficult for Korean financial com-

panies. This will also create a duration mismatch

between financing and fund usage. In addition, since

funds are raised through floating rates and invested at

fixed rates, this will also let financial companies

exposed to interest rate risk.


Table ⅢⅢ.4 2009 Project Financing LeagueTable

Note: 1) Global initial mandated lead managerSource: PFI magazine.

Mandated Arrangers1) US$(m)No ofdeals

1 State Bank of India 19,944.9 37

2 Calyon 7,359.6 80

3 BNP Paribas SA 5,836.1 63

4 Societe Generale 4,283.7 51

5 Sumitomo Mitsui Finl Grp Inc 4,025.1 40

6 IDBI Bank Ltd 3,989.2 11

7 Mitsubishi UFJ Financial Group 3,875.6 52

8 BBVA 3,641.3 54

9 Santander 3,344.4 55

10 Mizuho Financial Group 2,819.4 26

11 Standard Chartered PLC 2,805.9 21

12 Natixis 2,755.9 33

44 Korea Development Bank 637.2 8

83 KB Financial Group Inc 253.1 3

4. Ways of Enhancing the Role ofPrivate Finance

To enhance the role of private finance to win more

orders for overseas projects, ECAs, financial compa-

nies, and supervisory authorities should form shared

goals and design a roadmap.

First, ECAs have to establish the clear organizational

goal of actively supporting the development of the pri-

vate sector. For example, for foreign ECAs, a great

number of the employees are on secondment from pri-

vate financial companies, often trained for multiple

years, and then return back to the private sector. Fur-

ther, in Japan, a portion of the overall project funding is

mandated to be earmarked so that the private sector

takes charge of it, thereby gradually increasing private

participation. That is, policy finance institutions with

relatively greater experience must lead the incubation

of the private sector, and systems must be designed to

accurately evaluate these efforts.

Secondly, domestic financial companies need to view

participation in project financing as a long-term means

of diversifying revenue streams. Recent global tighten-

ing of capital requirements and greater restrictions on

business activities other than the financial intermediary

function mean that such forms of long-term loans can

be an attractive source of earnings for commercial

banks. That is, ECA-guaranteed loans deserve greater

attention since their risk weights are quite low and their

stability quite high. In addition, leading participation in

large projects can diversify earnings streams by creat-

ing an array of transactions beyond direct lending, such

as equity investment, financial advisory services, cash

flow management, and derivatives trading. Along with

this, stable FX financing at low rates through Korean

financial companies’ overseas branches is critical, and

this can be called yet another reason that the globaliza-

tion of Korea’s financial industry must not be put off

any longer.

Finally, the role of supervisory authorities is also key.

Since Korean banks’ portfolios are simple and biased

59Current Issues

Figure ⅢⅢ.5 Enhancing the Role of PrivateFinance

towards household lending and short-term corporate

lending, diversifying earnings streams and encouraging

overseas business for future growth is highly meaning-

ful. Supervisory authorities should provide incentives

when evaluating performance of financial companies

with strong records in overseas project finance, and

help financial companies strengthen their risk manage-

ment capabilities.

C. Policy Agenda for DomesticBanks' Foreign Expansion

Christopher Byungho Suh ([email protected])

1. Background

The demand for international banking, for examples,

financing, FX hedging and cash management service is

very large in Korea as its economy depends highly

upon international trade. However, domestic banks are

not globalized enough to meet those demands. More-

over, And the economy itself is vulnerable to foreign

exchange liquidity because of the fact that domestic

banks have no stable funding source aboard.

Therefore, it is imperative for the Korean government

to encourage domestic banks’ globalization through

foreign expansion. And it would be necessary for

domestic banks to expand abroad for sustainable

growth considering the fact that domestic market is

highly saturated.

2. Institutional Environment forDomestic Banks' ForeignExpansion

The institutional environment for domestic banks’ for-

eign expansion has recently improved as the govern-

ment exempted qualified domestic banks from the

screening process of opening up a new branch or sub-


sidiary abroad. The Korean Banking Law has been

revised last year such that only an ex-post notification

to the Financial Supervisory Committee (FSC) is

required for the installation of a foreign branch or sub-

sidiary if and only if all of the following conditions are

me the BIS capital adequacy ratio exceeds 10% the

overall rating from the Financial Supervisory Service

(FSS) is level 2 or higher, the installation does not

involve acquiring an institution with a credit rating of

B+ or lower, the installation does not involve opening

up a business line that is not allowed for Korean banks

or has not been conducted before the installation does

not involve entering into a country with a the credit rat-

ing of or B+ or lower and the installation does not

involve entering into a country that has not established

diplomatic relations with Korea.

However, there is more room to improve regarding the

institutional environment for domestic banks’ global-

ization. When a domestic bank attempts to acquire for-

eign banks using a tender offer, it needs to disclose its

intention, stock type and number, purchase terms, fund-

ing method and the purchasing agreement. Further-

more, it is impossible for a domestic bank to change the

purchase condition by lowering the acquisition price or

by extending the bargaining period because of article

136 and 145 of the Financial Investment Services and

Capital Markets Act (FSCMA). On the other hand,

domestic banks headquartered in the USA or the EU

need only to follow local regulations regarding tender

offer acquisition abroad because their governments

have exempted them from the domestic regulation in

case of cross-border acquisitions. This difference may

cause problems for domestic banks because they have a

comparative disadvantage in tender offer. And foreign

banks without such obligation will avoid co-investment

with domestic banks in tender offer investment because

the domestic regulation may jeopardize the whole

investment project.

Moreover, foreign subsidiaries of domestic banks need

to provide collateral when they borrow money from

their parent company according to article 22 and 48 of

the Financial Holding Company Law, whereas such

61Current Issues

obligation does not apply when the parent company

holds more than 80% of the total stake. The problem is

that most foreign investment involves investment con-

sortium, which ends up with stock ownership less than

80%. This may be problematic for the foreign operation

of domestic banks especially because they need funds

from their parent company as a small scale startup oper-

ation. And it also weakens domestic banks’ competitive

power abroad because US or EU banks do not follow

such obligation.

In addition, each foreign branch or subsidiary of

domestic bank is subject to evaluation from the FSS as

an independent entity. And the evaluation standard is

the same for each operation. This may cause trouble

because each operation is different in its local license,

history, size and business model. For example, it does

not make sense to evaluate a foreign branch with no

license to collect deposit based on its loan to deposit

ratio or newly opened branch based on profitability.

The US or EU governments do not evaluate different

foreign operations against the same standard.

It would be more reasonable to let domestic banks to

evaluate their own foreign operations, and the govern-

ment to evaluate the evaluation system of each bank.

Inspection of specific operations may be needed only

when there is an issue there.

Most of all, Korean banks are required to keep their

loan exposure to each foreign country below 10%

according to the FSS guideline. Therefore, a large scale

acquisition of foreign bank is practically impossible.

3. Evaluation of Domestic Banks'Foreign Expansion

The globalization measure for domestic banks is miser-

able. The representative measure of globalization

would be the Transnationality Index (TNI), which is

calculated as the average of foreign asset to total asset

ratio, foreign revenue to total revenue ratio and number

of foreign workers to total workers ratio. As of 2010,

the TNI of domestic banks is 2.9%, whereas it is 76.5%


Table ⅢⅢ.5 Performance of Domestic Banks'Foreign Operations

(Unit: billion USD, %)

Source: FSS, BOK.

2005 2006 2007 2008 2009

Total Assets 34.4 46.7 50.7 53.8 56.5

ROA 1.27 1.08 0.62 0.56 0.61

Substandardand Below 0.50 0.47 0.60 1.60 1.60Loans to

Total Loans

for UBS, 75.2% for Deutsche Bank, 64.7% for HSBC

and 43.7% for Citigroup. Even regional banks such as

Credit Agricole (37.4%) and Mitsubishi UFJ (28.9%)

have a wide difference with the domestic banks.

Domestic banks have started to increase their foreign

exposure, but the performance of domestic banks’ for-

eign operations is worsening. Domestic banks’ foreign

assets have increased from 34.4 billion dollars in 2006

to 56.5 billion dollars in 2010. However, the average

return on asset (ROA) has decreased from 1.27% in

2006 to 0.61% in 2010 mostly because of bad loans.

The sub-standard and below loans to total loans ratio

has increased from 0.50% in 2006 to 1.60% in 2010.

The recent slump in of foreign operations may stem

from the worsened local economy in the aftermath of

the global financial crisis. Since a large part of their

revenues came from loans to domestic companies’ for-

eign operations, their performance has also been

affected by the recent project financing crisis in Korea.

Moreover, foreign operations in China have suffered an

increase in costs as they were turned into subsidiaries

instead of branches.

Domestic banks have increased foreign subsidiaries for

localization, but most localization measures have wors-

ened. The ratio of the number of foreign subsidiaries to

the number of total foreign operation has increased

from 25.8% in 2008 to 31.5% in 2010, but the transna-

tionality index has decreased from 5.2% in 2007 to

3.6% in 2010. The local customers to total customers

ratio has decreased from 63.5% in 2008 to 63.2% in

2010, and the local funding to total funding ratio

35.1% in 2008 to 34.6% in 2010. This is because

domestic banks increased the number of local sub-

sidiaries by turning existing branches into subsidiaries

without acquiring local banks. And existing foreign

operations focused on stabilizing the business as the

asset quality worsened after the global financial crisis.

63Current Issues

Table ⅢⅢ.6 Localization Measure of DomesticBanks' Foreign Operations

(Unit: %)

Note: 1) (number of local subsidiaries/ number of over-seas branches) * 100

2) [(overseas branch assets / bank assets) +(overseas branches profit / Bank total profit) +(number of overseas branches / total number ofbanks)] * 100 / 3

Source: FSS.

Local Local Local Subsidiary Customers Funding TNI2)

Ratio1) Ratio Ratio

2007 N/A N/A N/A 5.2

2008 25.8 63.5 35.1 3.0

2009 30.2 64.3 34.3 2.7

2010 31.3 63.2 34.6 3.6

4. Policy Agenda for DomesticBanks' Foreign Expansion

Korean government has to improve the institutional

framework for domestic banks to expand abroad.

Firstly, it should abolish the 10% country limit for loan

portfolios so that domestic banks may acquire local

banks. Secondly, the domestic tender offer regulation

should not apply to cross-border acquisitions because it

limits domestic banks’ acquisition strategy choice.

Thirdly, the 80% rule for collateral requirement

between a subsidiary and its parent company should be

relaxed so that consortium investments are not penal-

ized. Fourth, the supervision of foreign operation

should focus on each bank’s management system of

foreign operation considering the limitation of the

inspection personnel.

Lastly, the Korean government should keep in mind

that global banks have grown through a series of cross-

border acquisitions and that successful investments

were the result of trial and error. It should promote chal-

lenging so that domestic banks can leap forward. Even

if some investments turn out to be unsuccessful, the

next investments will be more likely to be successful

because of the lessons learned from the past failures.


4-1 Myung-Dong 1-Ga, Seoul, 100-021, KoreaTEL : +82-2-3705-6108 FAX : +82-2-3705-6285

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