KDI - Korea Development Institute - RESEARCH - Research Areas

Summary

Policy Study KOR Analysis of Market Discipline at the Capital Market: The Case of Korea

This paper analyzes how the size of firms, unrelated to inherent credit risks, influences firms’ access to capital markets. Specifically, we theoretically and empirically whether credit rating agencies (CRAs) unduly give favors to large-sized companies and conglomerates than small and mid-sized companies when CRAs evaluate default risks of these companies on their debts. In a simple theory model in a Bayesian persuasion framework, we find that CRAs have an incentive to generously underestimate default risks on the large-sized firms when these firms raise capital from bond markets more often than small and mid-sized firms, and thus become a very important client to CRAs. However, the bond buyers rationally infer the default risks on these large-sized companies with high credit rating, and thus charges a higher risk premium than they would to small and mid-sized companies conditional on the same financial conditions. Using a financial dataset in Korea, we document that the interest rates of bonds issued by mid-sized companies are in fact lower on average than those issued by large-sized companies. We further find that mid-sized companies are less likely to receive a high credit rating than the large-sized companies. These findings suggest that CRAs unfairly treat companies willing to issue bonds based on their sizes, thereby possibly distorting credit market structures.

Summary

Research Monograph KOR Analysis of Behavioral Patterns of Government-funded Microfinance Users

Using data on personal credit information from the Korea Credit Bureau (KCB), this study examines the long- and short-term impact of Korea’s two representative political microcredit products: the Sunshine (Haetsal) Loan and New Hope Seed (Saehuimang Holssi, NHS) Loan. This study also analyzes the impact of the guarantee ratio level of the Sunshine-Loan on borrowers’ repayment capacity.

Around 2010, the interest rate for unsecured loans to borrowers with low credit scores (7 and below) was as high as 40%, and many were using predatory lending schemes that charge extremely high interest rates. To resolve the situation, the financial authorities put into operation political microcredit products for low-income, low-credit borrowers that charge lower interest than the market rate. But while there have been much criticism and speculation over the actual effects of these programs, they have not undergone any impact evaluations to examine whether those products should be sustained. In particular, the Sunshine-Loan suffers from a considerably high subrogation rate; making performance evaluations even more necessary.

In this context, Chapter 3 analyzes the long-term behavioral patterns of the borrowers of political microcredit products, including their average interest rates, cash advances, credit scores, credit card payments, and whether they filed for debt modification. It also summarizes how Korea’s credit loan market has changed after the launch of political microcredit products.

In Chapter 4 and 5, to discern the causal effects of the provision of political microcredit, this study constructed a control group of non-users who have similar traits to policy loan users through the propensity score matching (PSM) technique, and then analyzed the economic effects and performance of policy loans using the difference-in-difference (DID) method. Specifically, Chapter 4 examines the various aspects of the borrowers of the Sunshine Loan and NHS Loan in 2012 and 2014, such as DTI, credit card expenditure, credit score, average interest rate, etc. Chapter 5 looks into the changes in the use of high-interest rate unsecured loans provided by private money lenders and savings banks among political microcredit borrowers in 2016.

Chapter 6 analyzes the effects of the change in the credit guarantee ratio on the probability of filing for subrogation or debt modification among the borrowers of the Sunshine Loan with a logistics regression analysis.

The chapter can be summarized as follows. Borrowers of the Sunshine Loan and NHS Loan show a larger increase in credit card expenditure than non-borrowers, meaning that the provision of microcredit can reduce borrowing constraints and encourage consumption. However, six months later, borrowers exhibit lower credit scores than non-borrowers as well as an increase in their DTI ratio. Moreover, the likelihood of borrowers filing for debt modification decreases only for a short period. These results suggest that another policy is needed for the borrowers of the Sunshine Loan and NHS Loan to support long-term credit management.

According to the analysis in Chapter 5, the probability of taking out unsecured loans from private money lenders and savings banks was significantly low during the early period of loan issuance. But this increased dramatically, and even exceeded that of non-borrowers after six months among Sunshine- Loan borrowers and after two years among NHS-Loan borrowers. This reaffirms the necessity of a support policy for long-term credit management so that borrowers do not have to take out other loans that charge high interest rates.

The analysis results in Chapter 6 show that when the Sunshine Loan’s credit guarantee ratio is low, the probability of subrogation and debt modification decreases. It is found that borrowers who are given a credit guarantee ratio of 85% are 30%p less likely to choose subrogation and 17%p less likely to file for debt modification, compared to those given a ratio of 95%. This means that a high credit guarantee ratio could actually weaken financial institutions’ efforts such as ex-ante screening and ex-post monitoring.

Based on the analysis results of this study, three policy implications can be drawn upon. First, government-funded political microcredit need to be combined with credit management education and credit counseling to help borrowers to manage their credit scores on their own and in the long-term. Second, instead of simply taking out lump sums that are close to the borrowing limit at once, borrowers need to be encouraged to borrow multiple times, and only the amount they can repay at each time, which could help maintain the positive effects of public microcredit in the long-term. Additionally, this method is expected to slash the commission for loan agents and to help borrowers repay their debts on time. Third, the credit guarantee ratio for the Sunshine Loan, which is currently at 95%, needs to be lowered to below 85% so that financial institutions are able to conduct ex-ante screening and ex-post monitoring in a comprehensive and timely manner.

Summary

Research Monograph KOR A Political Economic Study on Korea’s Financial Supervisory System

In a free and competitive financial market, resources are efficiently allocated via interest rates—i.e, the price of money—not only enhancing total output, investment and employment but also driving out or restructuring inefficient firms. Indeed, a well-functioning financial market, by allocating financial resources, fosters new firms consistently to enable competition between efficient firms, promotes investment to enhance productivity and increases employment to nurture economic growth. However, there is the possibility that private financial institutions will take unduly high risks driven by excessive profit seeking, and such a practice, if unchecked or poorly managed, can pose a serious threat to the entire financial system. This is why financial regulations and supervision are needed.

As such, certain premises are assumed for an efficient and stable financial market, which include an advanced private financial market, minimized government role and guaranteed independence of the financial supervisory authority. Nevertheless, governments are often tempted to intervene in the private financial market for a range of reasons—underdeveloped financial market, pressure from concerned interest groups/political parties, industrial upgrading, short-term economic stimulus and so on. Given the high information asymmetry in the financial market, government intervention will disrupt the allocation of credit into where it could be used most efficiently, meaning a loss of the financial market’s functional efficacy. Even in such cases, if the government remains only as a ‘regulator,’ the supervisory authority―independent from the government―would be able to put certain restrictions on government intervention, but if the government holds the authority to supervise, too, its intervention in the financial market would be like a car without brakes.

This study adopts various angles to address the structural problems within the financial market in which conflicts of interest reside over pressure from interest groups/ political parties, industrial upgrading and short-term economic stimulus. Furthermore, the ultimate purpose of this study is to redefine the role of government in the financial market and to draw upon measures to minimize the problems arising from conflicts of interest.

Summary

Policy Study KOR Economic Dynamism of Korea: With a Focus on the Economic Concentration of Business Groups

The gross domestic product (GDP) growth rate of South Korea has declined since 2011 mainly due to dampened growth in total factor productivity (TFP). By studying changes in productivity growth from 2006 to 2015 with firm-level microdata, this paper shows that a decrease in allocative efficiency across firms can account for the recent dampened aggregate productivity growth and that most of a decrease in allocative efficiency since 2011 can be attributed to firms affiliated with business groups subject to the limitation on cross-shareholding designated by the Fair Trade Commission. Given the fact that business groups’ shares in input markets have been steadily rising, the economic concentration of business groups can be a main factor in the recent misallocations, which give rise to the diminished economic dynamism and dampened TFP growth of South Korea.

Summary

KDI Policy Forum Improving Capital Regulations on Financial Institutions to Reflect Group-wide Risks

□ The group-wide risks associated with business group affiliation must be reflected in capital regulations that assess the soundness of financial institutions.

- When financial institutions hold shares with the intent to maintain control over a business group, the insolvency of one affiliate could rapidly spread throughout the entire group due to difficulties in disposing of the respective shares.

- If such risks are not reflected in capital regulations, the capital adequacy of financial institutions [in groups] against losses may be assessed inaccurately.

□ It was found that the current capital regulations on insurance and securities companies do not reflect the group-wide risks posed by affiliates?? investments in shares.

- The risks may be underestimated for capital regulations on insurance companies as the companies?? investments in non-consolidated affiliates are regarded as general stock investments.

- As for capital regulations on securities companies, capital adequacy may be incorrectly assessed due to the deduction of the whole investment in affiliates from their capital.

Summary

Policy Study KOR A Study on Minimum Capital Requirement Regulation on Financial Conglomerates in Korea

This paper investigates whether the current minimum capital requirement regulation properly evaluates a group-wide risk exposed to financial firms when they are affiliates of conglomerates. Particularly, we check how each sectorial capital requirement regulation assesses the risks exposed to the regulated firms by holding the shares of the other affiliates in the same group. By comparing with the international standard of group-wide capital regulation suggested by Joint Forum (1999), we find that the capital regulation for insurance companies underestimates the risks associated with holding the shares of non-financial affiliates.

This paper further provides analysis for an optimal regulatory design on how to induce financial conglomerates to prudently manage the group-wide risks exposed to their financial affiliates. To this end, we present a model in which the group owner can expropriate the financial affiliate’s ability to raise funds to buying the shares of the other affiliates for the purpose of controlling. We find that an optimal regulatory response to the financial affiliate’s inefficient share purchase decision varies with the types of incomplete information. If the inefficiency arises from the owner’s private information on non-profitability of the affiliates, it will be optimal to separate financial entities from commercial entities. However, if the inefficiency arises from the controlling financial firm’s imprudent monitoring of the controlled affiliates, imposing additional required capital on the controlling financial affiliate can achieve the (constarined) efficiency.

Summary

Policy Study KOR Private Equity Fund’s Role in Ex-ante Korea’s Corporate Restructuring

Recently, corporate restructuring has been a critical issue since the profitability of businesses has been deteriorating, followed by years of low growth with the increase of marginal firms. Main corporate restructuring schemes consist of corporate structure improvements, “workouts” by voluntary agreement of the creditors and corporate rehabilitation proceedings or “court receivership” by court. This institution and court-led, ex-post corporate restructuring basically targets firms with insolvency issues, leading to firms paying painstaking costs, such as significant job losses, fire sales, and conflicts of interests among stakeholders. Therefore, as an alternative measure, corporate restructuring scheme by capital market, particularly through private equity funds, gained popularity as the ex-ante, preemptive complementary corporate restructuring scheme takes place before insolvency and is thereby considered more effective in that it can reduce agent costs by taking control of management and increasing monitoring capabilities.

This study investigates how to vitalize private equity in Korea as an alternative corporate restructuring mechanism by empirically analyzing whether Korean private equity funds have increased operating performances of the firms they invest in and drawing policy implications based on empirical results. We could not find supporting evidence that the Korean private equity is able to improve operating performance of the firms it invested. This empirical result might be because private equity in Korea play the role not as buyouts, which were the original purpose of introducing private equity in Korea, taking control of management and executing turnarounds for under-performing companies, but as growth capital, which provides timely financial resources to companies relatively young, similar to venture capital.

For invigorating private equity as an corporate restructuring scheme government deregulation is in need to foster the dynamism and innovativeness of the Korea private equity industry because regulations on private equity funds that guide towards executing buyouts might limit private equity activities. The private equity industry itself should also build up capacity through making efforts (e.g. hiring professional management teams). Furthermore, the enlargement of private equity funds in size is necessary to carry out market-friendly corporate restructuring for the likely increase in the demand for corporate restructuring, in particular for large companies.

Summary

Policy Study KOR Short-Sale Restrictions and Market Quality in the Korean Stock Market after the 2008 Global Financial Crisis

Since 2008, a number of regulatory authorities have disallowed short sales, considering their negative impact on the market. The short selling ban in Korea lasted exceptionally longer than that of other major countries for both financial and non- financial stocks. This is surprising because Korea is one of countries whose markets were stabilized from the 2008 financial crisis relatively early and its market instability did not last long during the European financial crisis in 2011.
We analyze whether the short selling ban contributed the early market stabilization by controlling price depreciation and volatility in Korea or whether it negatively affected the stock market efficiency and quality by enforcing restriction on the stock market for an excessively long period of time.

Our paper differs from existing papers in the following senses. First, we analyze the effect of a short selling ban using the stock market order book, making it possible to use intraday prices and analyze the effect of a short selling ban using the spread, bid residuals, and order imbalances from the order book. Second, our research focuses not only on a time series analysis of the market quality before and after short selling, but also deals with cross-sectional analysis. Third, we evaluate the short selling ban and market efficiency of many leading countries.

We find the followings. First, short selling ban could not reduce market volatility. Moreover, in the case of the non-financial stocks, market volatility decreased even though the short selling ban was lifted. These results suggest no evidence that short selling increases market volatility.

Second, spread did not decrease when compared to the period before the ban even though the volume increased moderately during the ban period. Also, decreasing amount of spread was more noticeable for non-financial stocks than financial stocks after lifting the short sales ban. These results suggest that short sellers have emerged as a liquidity provider, contributing to the market efficiency.
Third, as a result of the short selling ban, ask price residual quantity decreased relatively more for non-financial stocks. In other words, the imbalance of ask residual quantity decreased significantly during short selling ban period, in which the bid submission of short sellers was banned. Short sellers contribute to the market depth and asymmetry of the order imbalance.

Overall, we conclude that short selling provides liquidity to the market and improves market quality, suggesting that short selling restriction leads to costs that hamper market efficiency.

Based on results from the empirical analysis, this paper suggests that regulatory authorities consider short sale ban on a certain stock rather than on the whole sector such as non-financial and financial stocks. In this way, the risk of the regulation acting as a hindrance to market efficiency can be minimized. The period of short sale ban should also be restricted to a minimum length of time, and the effect of the prohibition should be evaluated after a certain period of time to decide whether to extend the ban period.

Summary

Policy Study The Effects of Central Banks’ Rate Change Patterns on Financial Market Variables

This study examines whether different patterns of change to the benchmark interest rates of central banks are associated with their contributions to variances in the forecast errors of three financial market variables: the long-term interest rate, the foreign exchange rate, and the stock market index. On average, the central bank’s interest rate accounts for approximately 20% of the variance in each variable. We find that the total range of changes is more important than the frequency of changes. The panel regression shows that the range and frequency of policy rate changes is positively associated with the volatility of long-term interest rates but no association with the volatilities of stock prices and exchange rates. These results suggest that small and frequent adjustments of policy rates are desirable for reducing the volatility of interest rates.

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