Performance Evaluation of Foreign Banks in South Korea

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INTRODUCTION

Korea has been a very attractive market for foreign banks because of their excellent earnings records in the past and the bright. outlook of the Korean financial market. It has been reported that net earnings of foreign banks operating in Korea in the past years have been consistently increased (The Bank of Korea, 1991).

The results of this paper should be of special interest to the banking industry of the U.S. because the U.S. banks have dominated both in number and in their share. As shown in Table 1 (omitted), about 37 percent of the foreign banks currently operating in Korea are American banks.

A HISTORY OF FOREIGN BANKS IN KOREA

In 1962, the Korean government launched the first of its ambitious Five Year Economic Development Plans. As an under-developed country in the early 1960s, Korea was not able to obtain internally the required resources for implementing the plan. To finance the plan, business and government used commercial loans from financial institutions in industrialized countries, especially those from the U.S..

However, there was some concern that the domestic banking system was not strong enough to compete with foreign banks. The domestic banking system in operation at this time was established in 1950 with the Bank of Korea Act and the General Banking Act, and was not ready to compete with well-developed foreign banks. Korea, however, decided to admit foreign banks because it believed that, in the long-run, the presence of foreign banks would be beneficial to the economic development of the country. Government officials also believed that for Korean banks to do business in other countries, it was necessary to allow foreign banks to operate in Korea. The Chase Manhattan Bank opened a branch in July, 1967 as the first foreign bank in Korea. During 1967, four other banks opened branches: Citibank, Bank of America, The Bank of Tokyo, and Mitsubishi Bank. It comes as no surprise that these pioneers were American and Japanese banks, because trade with the U.S. and Japan accounted for over 60 percent of the import/export market at that time.

Until 1976 only 11 foreign banks were operating in Korea. During 1977 and 1978, 19 more foreign banks were added. It is due to a more aggressive government policy aimed at greater participation in the international financial market, coupled with a rapid expansion of the Korean economy.' Since then, the number increased steadily, and reached 68 branches and 19 offices on June 1992. Twenty five branches and 3 offices of American banks are currently operating, followed by Japan with 14 branches and 9 offices (see Table 1). More than half of the branches and offices of the foreign banks are from the U.S; and Japan.

REGULATIONS ON FOREIGN BANKS

Foreign banks in Korea have had a mixed history of restriction and preferential treatment. In the 1960s and early 1970s, many privileges were granted to foreign banks to entice them to open branches in Korea, which was at that time a risky and developing country. Some profits were guaranteed by the government. Yet, many restrictions were imposed on their operations because the government was concerned that they might take over the domestic financial market.

In the 1980s, many changes took place in the Korean economy as well as in its banking systems. Many regulations on existing foreign banks were changed.

As the Korean government was liberalizing its banking systems, it took some protective measures that went against the foreign banks. In 1982, a mandated reduction became effective that lowered from 15% to 10% the percentage of loans to local borrowers that foreign banks could hold as security in the form of compensating balances. Now the banks had to pay interest on what had formerly been interest-free balances. Furthermore, new limits have been placed on foreign bank participation in Korean foreign exchange markets, domestic bond markets, and commissions earned on letters of credit. …