On June 30, 2000, Korean commercial banks disclosed potential losses in their assets in accordance with the stricter disclosure rules of the forward looking criteria (FLC). Potential losses refer to losses that would additionally be incurred following the application of the FLC to all borrowers. As of end-March 2000, potential losses amounted to 3.9 trillion won, including those newly accrued through the end of June. In addition, commercial banks will be required to transform into “clean banks” through the swift resolution of impaired assets and reinforcement of capital bases.
In this regard, the FSS announced policy measures to enhance the transparency of bank management. Under the new measures, potential losses will be reflected in banks’ income statements within the time framework agreed to with the IMF in order to promote investor confidence and to expedite completion of management normalization efforts at commercial banks. Additional injections of public funds will also be considered if deemed necessary and under the strict condition of more vigorous self-rescue efforts in place.
Background
The FSS introduced the FLC as the new standards for asset classification effective from December 31, 1999, in order to fully incorporate a borrowers’ capacity to repay loans. However, investor confidence has not been restored to the targeted level due mainly to market perceptions that banks remain vulnerable to unrevealed potential losses.
In fact, impaired assets related to companies currently under workout programs have been given preferential treatment in the course of pursuing corporate sector restructuring. Loans extended to companies under workout programs were classified as either “precautionary” or “substandard” and are required a minimum 2 to 20 percent loan loss provisioning. Also, the FLC was not able to account for potential losses in companies under court receivership and court mediation procedures as well as losses resulting from holding secured CPs issued by the insolvent Daewoo Group. Loans extended to companies under court receivership or mediation procedures were to be reclassified as “normal” if they fulfilled the requirements as set in their Capital Structure Improvement Plans (CSIPs) and, as a result, business operations were deemed to have returned to normal.
In order to eliminate uncertainties in financial markets and to regain investor confidence, it has been deemed necessary to assess the accurate amount of total potential losses at commercial banks and to disclose the figure with full transparency.
Potential Losses in the Banking Sector
Potential losses of 3,939.3 billion won were calculated by subtracting cashable loan-loss provisions of 1,175.5 billion won from reassessed total losses of 5,114.8 billion won. By source, total losses were comprised of 1,105.9 billion won in Daewoo-related losses, 2,087 billion won from workout companies other than Daewoo, and 936.5 billion won from companies under court receivership, mediation, and others.
The figures are based on an assessment without such exceptions and according to the strict criteria. First, Daewoo Group companies, non-Daewoo workout companies, and companies under court receivership and mediation were all treated without exception, (i.e. loans to some of those companies were reassessed to be classified down to “doubtful” and “estimated loss”) following a five stage classification scheme and provisioning criteria. Second, potential losses were reassessed to account for the closures of insolvent subsidiaries as well as an evaluation of their equities. Third, companies that entered into a debt rescheduling process or that were reclassified as “substandard” and below after the end of March were all accounted for. Fourth, in the cases that banks applied different criteria for a company, uniform criteria were applied across the board with the most conservative one set as the norm. Fifth, all securities and bonds subject to the mark-to-market valuation scheme were assessed accordingly, and those subject to the old criteria of book value were reassessed with the discount rate applied for impaired assets held by ITCs.
Policy Measures
First, all potential losses that are assessed and revealed at this time will be reflected in banks’ income statements within the timeframe agreed to between the FSC/FSS and the IMF. It is expected that commercial banks will be able to fully absorb the total amount of potential losses, and the FSS is therefore consulting with the IMF to cease exceptional treatment for loans to workout companies prior to the end 2001.
Second, the clearance of impaired assets will be expedited in order to facilitate the transformation of commercial banks into “clean banks.” It has been pointed out that the requirements for write-offs in Korea are more stringent than those of the major industrialized nations. Currently, loans classified as “doubtful” and “estimated loss” can only be written off, which has impeded timely write-offs and contributed to exaggerated figures of impaired assets, especially for “classified loans” that refer to loans falling into substandard and below. Therefore, the FSS plans to address these issues by adopting similar practices and standards for write-offs as in other developed countries. Also, the recoverable portion of impaired assets will be cleared through the issuance of Asset-Backed Securities (ABS) or by a Corporate Restructuring Vehicle (CRV). The enactment of the Law on CRV will be made in due course. KAMCO will also provide the source of funds through structural adjustment loans from the IBRD as well as recycled assets.
Third, all commercial banks are advised to revise their management improvement plans to include a plan for clearing impaired assets and a plan for improving their BIS capital adequacy ratios. If banks are expected to fail to meet the minimum BIS capital ratio of 8% with potential losses accounted for, the FSS will invoke PCA measures and require the banks to submit self-rescue plans for the signing of an MOU for management improvement. If the FSS determines that a bank has failed to take adequate self-rehabilitation measures, it will hold senior management accountable and provide public funds on the strict condition that the bank introduces a more vigorous self-rescue program. If this is the case, however, in order to maintain transactional and customer relationships, banks that receive public funds will be affiliated to financial holding companies rather than be normalized through purchase and assumption (P&A). If the FSS determines that a bank is successfully implementing self-rescue efforts, however, it will allow the bank to remedy the decrease in its capital adequacy ratio on its own.
* Please refer to the attached file for details.