Korea`s financial reform since the early 1980s may be
characterized as cautious in terms of the sequence of
liberalization in different markets, speed of liberalization and
avoidance of other complications. Curbing inflation was the top
economic management priority in the early 1980s. This policy
was viewed as critical not only for the maintenance of economic
growth potential by inducing resources to more productive
sectors, but also for deregulation of interest rates and other
liberalization efforts.

Stabilization efforts were accompanied or followed by a
process of economic liberalization. Industry-specific promotion
measures were gradually replaced by a more indirect and
functional support of industries, and a significant progress was
made in trade liberalization. Financial liberalization emphasized
relaxing administrative controls over bank management,
privatization of banks, lowering entry barriers, and diversifying
financial services. With limited progress in the interest and
exchange rate deregulation, liberalization of external capital
transactions would complicate macroeconomic management due
to the possibilities of capital flight, excessive foreign capital
inflow, or distortion of the exchange data. Delayed opening of
the capital accounts in Korea has prevented major interferences
from occurring with the process of import liberalization and
monetary management.

Domestic financial liberalization in Korea has been rather
slow in such areas as deregulation of interest rate, reduction of
policy loans and enhancement of autonomy in bank management.
This slow pace was, to a large extent, due to the legacy of
extensive government intervention in resource allocation during
the 1970s. Snowballing nonperforming bank loans as well as
inertia and incompetence of banks prevented any both financial
liberalization programs, which would have driven banks to
complete with much healthier NBFIs. Continued role of the
major nationwide commercial bans have self-perpetuated the
delay in financial liberalization. Splitting the nonperforming loans
from the creditor banks for special treatment while inducing
them to vigorous competition was another solution, but was
ruled out because of its political sensitivity.

Another big obstacle to financial liberalization has been the
government efforts to keep investment activities vigorous for
sustained economic growth. A drastic increase in corporate
financing cost, which may result from interest rate deregulation,
would certainly be a heavy burden for most Korean firms with
highly leveraged capital structure. However, high market interest
rate is inevitable given the low level of financial development
and strong investment needs. Frequently forgotten is that, by
delaying deregulation, the situation will get even more difficult
to tackle. Government`s desire to save its cautious approach
towards interest rate deregulation. Reduction of policy loans has
also been slow for the similar reason as well as with growing
concern over social equity.

Another feature of the Korean financial reform is the rapid
growth of NBFIs, which have not been subjected to such strict
government regulations as it has applied to banks. NBFIs have
been favorably treated in regards to interest rate control, burden
of providing policy loans, entry barriers and ownership
regulation. This differential treatment between banks and NBFIs
has been the result of government`s efforts to redress the
dualistic financial market structure by absorbing informal curb
market funds into the organized credit market. The Korean
financial market as a whole has become fairly liberalized, simply
because the share of NBFIs, which operate in relatively free
environment, has risen significantly. Promotion of NBFIs has
proved to be a pragmatic way of deepening the financial market
while maintaining government-controlled credit allocation through
the banking system. The consequences of this policy have been
inefficiency in banking system. The consequences of this policy
have been inefficiency in banking, various government
assistances to banks, slow progress toward a universal banking
system lack of competition in the financial market, and delayed
financial liberalization.

Finally, Korea`s cautious approach to financial liberalization
and the differential treatment between the banks and NBFIs
were no exceptions in ownership restriction for financial
intermediaries. Concern over the possibility of large business
groups controlling the newly privatized nationwide commercial
banks led to a new provision that sets the maximum a share
holder can hold to 8% of the total equity. This concern is
justified given that the banks still provide a substantial portion
of their credit at subsidized rates to large business groups in
return for various government assistances, and that these groups
usually operate in very oligopolistic markets allowing them to
easily abuse conflicts of interest. The ownership restriction
coupled with tighter credit control to large business groups since
1984 and the continued government appointments of bank top
management have discouraged business firms to making equity
investments in these banks.

Ⅰ. Introduction
Ⅱ. Legacies of the 1970s: The Pre-Reform State
1. Government Intervention in Resource Allocation
2. Consequences of Intervention
Ⅲ. Economic Liberalization in the 1980s
1. Dealing with Internal and External Macroeconomic
Imbalances in the Early 1980s
2. Process of Economic Liberalization
3. Process of Domestic Financial Liberalization
Ⅳ. Effects of Financial Liberalization
1. Interest Rate Movements
2. Growth of Financial Markets
3. Portfolios of Financial Intermediaries
4. Efficiency of Credit Allocation
5. Non-performing Loans and Government Bailout Policy
Ⅴ. Main Features of the Korean Financial Reform
1. Slow Pace of Financial Liberalization
2. Rapid Growth of Nonbank Financial Intermediaries
3. Delayed Opening of Capital Accounts
4. Government Control of NCB Management with Dispersed
Ownership
Ⅵ. Summary and Conclusion