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KoreanEconomic
FinancialReview
&
Vol.16 | No.4 | October 2011
President and Publisher
Tae-Joon Kim tjkim@kif.re.kr
Contributors (in alphabetical order)
dennis@kif.re.kr
ydkim@kif.re.kr
jhkoo@kif.re.kr
leekb@kif.re.kr
mhlee@kif.re.kr
soonholee@kif.re.kr
slee@kif.re.kr
yslee@kif.re.kr
hjlim@kif.re.kr
hslim@kif.re.kr
hsnoh@kif.re.kr
swpark@kif.re.kr
Dennis Kim (English Editor)
Young Do Kim
Junghan Koo
Kyoobok Lee
Myungwhal Lee
Soonho Lee
Sukho Lee
Yoonsok Lee (Editor)
Hyungjoon (Ray) Lim
Hyoung-Seok Lim
Hyoungsik Noh
Sungwook Park
The Korean Economic and Financial Review, October, 2011, Vol.16, No.4. 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, 11 Gil 19 Myung-Dong,
Chung-Ku, Seoul, Korea 100-021.
Copyright 2011 by the Korea Institute of FinanceSeoul, Korea. All Rights Reserved
Printed by KM
Printed on October 31, 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 22
1. Global Economy and Balance of Payments (Sungwook Park) 22
2. Economic Growth (Myungwhal Lee) 24
3. Inflation (Kyoobok Lee) 26
ⅡⅡ. Financial Markets and IndustryA. Asset Prices
(Kyoobok Lee, Sungwook Park, Hyungjoon (Ray) Lim) 27
1. Recent Trends 27
2. Outlook for 2011 30
B. Money and Credit (Kyoobok Lee) 31
C. Financial Industries 34
1. Banking Industry (Hyoungsik Noh) 34
2. Non-Banking Financial Institutions (Soonho Lee) 38
3. Securities Industries (Junghan Koo) 42
4. Insurance Industry (Sukho Lee) 44
ⅢⅢ. Current IssuesA. Analysis of the Determinant of Non-banking Financial
Corporates’ Interest Rates (Kyoobok Lee) 48
B. How to Boost the Lagging High Yield Bond Market
(Hyungjoon (Ray) Lim) 53
C. Developing Securities Lending Transaction in Korea
(Young Do Kim) 57
Macroeconomic Developments
The Korean economy appears to remain on an overall
recovery track, although its strength has slightly weak-
ened in Q2 2011. It is showing a steady pace of growth
with an increase in export and an improvement in
employment conditions. The Korean economy is
expected to continue its recovery, but it will probably
weaken in H2 2011. The upward trend of exports will
likely slightly moderate in H2 because the global econ-
omy has shown signs of slowdown and downside risks
are growing.
Outlook for 2011
The Korean economy is expected to continue its recov-
ery, but it will probably weaken in H2 2011. We fore-
cast GDP growth rate at 3.9% YoY this year led by the
expansion in export growth and private consumption.
By expenditure, exports and private consumption are
each expected to increase by 10.8% and 2.6% YoY. We
also expect facilities investment and construction
investment to be 7.3% and △4.4% YoY in 2011.
Exports and imports are expected to increase by 20.1%
Despite signs of global economy slowdown and lingering downside risks, the Korean economyappears to remain on an overall recovery track. The economy is expected to weaken in the secondhalf of 2011 due to sluggish growth in private consumption and exports and we have revised ourearlier projection of 4.4% growth downward to 3.9% this year. Current account surplus has beenrevised upward slightly due to slower growth in imports. Growth opportunities of and profitabilitylook stable in the Q3 although growth should be limited. With the possibility of loans becoming dis-tressed, credit finance companies and mutual cooperations will be required to improve their creditrisk management. The asset size and profitability of securities firms in Q4 2011 are expected to fallbecause of negative external factors, such as debt crisis in the Eurozone and uncertainty in the USeconomic rebound.
Overview
Korean Economic and Financial Review [October 2011]4
and 24.7%, respectively, in 2011. Therefore, the bal-
ance of payments is expected to register a current
account surplus of USD15.4 billion in 2011, smaller
than the USD28.2 billion figure from the previous year.
The reduction should occur mainly from a faster recov-
ery of imports than exports and heightened raw materi-
als prices.
Financial Markets
Money market rates increased for the most part in H2
2011 compared to H1 following a change in the Bank of
Korea's monetary policy. Meanwhile, long-term market
interest rates were influenced by the increase in the
base rate as well as external risks. With the BOK
expected to maintain its stance on monetary policy, the
yield on Treasury bonds (3yr) is expected to be 3.5% in
H2 2011.
In 2011, the KRW/USD exchange rate is expected to
average KRW1,111 down from the KRW/USD 1,156 in
2010. Throughout the remaining period of 2011, the
KRW/USD is expected to stay at a somewhat elevated
level with high volatility. This is because of strong risk
aversion, which has led to large sell-offs of emerging
market assets in the international financial markets,
does not look like it is going to easily disappear until
the eurozone forwards a concrete plan for Europe's fis-
cal crisis.
The Korea Composite Index (KOSPI) ended Q3 2011
at 1,770 points, down 331 points from the end of the
previous quarter. The index was negatively affected by
the resurfacing of the fiscal crisis in the euro zone and
by concerns over the global economic recession stem-
ming from a stagnant US growth. In Q4, the KOSPI is
expected to hold steady around its present level.
Money and Credit
In July and August, the low rate of growth in the money
supply continued mainly as a result of the tight-money
Overview 5
policy. While the average growth rate of M2, or broad
money in July and August, increased to 3.6% y.o.y.,
0.1%p higher than the second quarter, those of reserve
base and M1 fell to 11.5% and 4.6%, respectively.
In Q3 2011, total commercial bank lending to corpo-
rates and households increased by KRW13.8 trillion
and KRW5.5 trillion won. Overall, bank lending will
not increase much as banks will be expected to focus on
improving their risk management in line with higher
levels of global uncertainty.
Financial Industries
In Q2 2011 Korean banks’ assets decreased slightly
whereas the net income showed a huge increase. Both
NPL ratio and coverage ratio slightly ameliorated. Both
BIS ratio and Tier 1 ratio continued to improve. In Q4
2011, growth opportunities lies in loans and improve-
ment in profitability will manifest in interest income.
While asset soundness is expected to be maintained,
capital adequacy ratio is expected to slightly deterio-
rate.
In Q2 2011, except for venture capital companies and
mutual savings banks (MSBs), most non-banking
financial institutions experienced asset growth. The net
income of non-banking financial institutions was posi-
tive except for MSBs. The SBL of credit card compa-
nies, credit finance companies and Mutual Credits
(MCs) was improved slightly or largely unchanged.
But the loan soundness ratios of MSBs deteriorated sig-
nificantly. The capital adequacy ratio of MCs and credit
finance companies increased, but the ratio of credit
cards companies and MSBs decreased.
The assets of securities companies increased 23.1% in
Q2 2011 from the same quarter last year. Profits also
went up from increased brokerage commissions and
asset management service fees. Capital adequacy dete-
riorated due to increased interest rate risk in bond hold-
ings. The asset size and profitability of securities firms
in Q4 2011 are expected to fall because of negative
Korean Economic and Financial Review [October 2011]6
external factors, such as debt crisis in eurozone and
uncertainty in the US economic rebound.
At the end of Q1 FY2011, premium income of life
insurers recorded KRW19.5 trillion, up 1.4% y.o.y.
Direct premiums written for non-life insurers during
the same period were up 14.0% y.o.y. to KRW13.4 tril-
lion. While total assets and premium income of both
life insurers and non-life insurers are forecast to main-
tain the growth trend during Q3 FY2011, the growth
rate could weaken somewhat due to continued uncer-
tainties in the global and domestic financial market
environment.
Current Issues
The first paper analyzes how non-banking financial
companies’ interest rates have been determined and
finds that lending rates related not credit risk or target
rates but overall economic condition. The main reason
that lending rates are insensitive to a market rates
would be low price elasticity of loan with imperfect
market competition between financial companies and
asymmetric information. Therefore, in conclusion, a
couple of ways to enhance market competition and effi-
ciency are discussed.
The second paper deals with lagging high yield bond
market. The high yield bond market has been in dol-
drums since the onset of the global financial crisis in
2008. A well functioning high yield bond market is
important for the economy: it helps not only firms'
restructuring by funding LBOs and M&As, but also
growth companies to raise capital. Against such back-
ground, we propose the policy measures that would
promote the high yield sector: making investment pro-
tocols of institutional investors attuned to their appetite,
the introduction of fund credit rating system, and
enhancing the risk underwriting of security companies
and others.
The last paper suggests ways to develop the securities
lending transaction in Korea. In Korea, there has been
Overview 7
continuous system improvement to activate security
lending but there still are inconvenient to check details
on each security lending transaction. The Balance of
stock lending transaction in Korea shows a upturn trend
again in recent year after rapidly decreasing. Also, the
balance of domestic bond lending transaction has
shown a continuous increasing trend and domestic
investors take absolutely high proportion in loan and
borrowing of bond lending transaction. Overall, secu-
rity lending market can enhance liquidity of the market
and function of price discovery and contribute to
advancement of the domestic capital market by giving
an opportunity to increase revenue to borrowers and
lenders. Therefore it is beneficial to develop it.
Korean Economic and Financial Review [October 2011]8
A. Demand and Supply
1. Aggregate Demand
Hyoung-Seok Lim (hslim@kif.re.kr)
The Korean economy appears to remain on an overall
recovery track, although its strength has slightly weak-
ened in Q2 2011. Exports continued to show high
growth and domestic demand has steadily increased.
Labor market conditions have also remained on track
for improvement. Still, there are lingering uncertainties
as to the economic growth path owing to internal and
external risks.
Real GDP (chained volume measure) increased 3.4%
YoY in Q2 2011. On the production side, manufactur-
ing saw high growth, and other sectors also notched
positive growth except for construction. Although
manufacturing and services each increased by 7.2%
and 2.6% YoY, construction sank by △7.6% YoY in Q2
2011. On the expenditure side, private consumption
and exports showed sustained growth. However,
investment shrunk in Q2 following the previous quar-
ter. (Table Ⅰ.1).
Domestic shipments and exports maintained their
Macroeconomic Developments 9
The Korean economy appears to remain on an overall recovery track, although it has slowered itspace in Q2 2011. Exports continued to show high growth and domestic demand has steadilyincreased. We forecast GDP growth rate at 3.9% YoY this year, a drop of 0.5%p from the Augustforecast, led by the expansion in export growth and private consumption. Growth is also forecastedto be 3.9% YoY in H2 this year. Strong growth in exports will moderate slightly in H2 because theglobal economy has shown signs of slowdown amid increased downside risks. We expect inflationto slowdown to the mid-3% level in Q4 largely due to the base effect but shall be limited in any caseof won depreciation. Overall, risks concerning the European fiscal crisis is expected to overshadowany rosy expectations of the economy and uncertainty will remain the keyword in Q4.
Ⅰ.Macroeconomic Developments 1
FigureⅠⅠ.1 Monthly Shipments Indices
Source: National Statistical Office (NSO).
FigureⅠⅠ.2 Industrial Production Index
Source: NSO.
upward trend in spite of a slower pace of increase.
These had gone up by 2.7% and 6.3% YoY in August
2011 (Figure Ⅰ.1).
Industrial production and service industry production
continued to increase. The industrial production index
increased by 4.0% and 4.8% YoY in July and August
following a 7.2% upswing in Q1 2011 (Figure Ⅰ.2).
The service industry activity index registered an
increase of 3.8% and 4.8% YoY in July and August
2011 (Figure Ⅰ.3).
Economic Growth
The Korean economy has continued its growth trend in
spite of domestic and external uncertainties. All expen-
diture sectors have been in an upswing and exports, in
particular, have contributed considerably to the growth.
The Korean economy is expected to continue its recov-
ery, but it will probably weaken in H2 2011.
The economic growth rate increased by 3.4% YoY,
which has slightly weakened decreasing in 0.8%p than
Q1, in Q2 2011 and 0.9% over the previous quarter. All
expenditure sectors have maintained their upward trend
except for those of construction investment. In particu-
lar, private consumption and goods exports contributed
to a sustained upturn to positive ground.
Exports in the national accounts grew 9.6% YoY in Q2,
centering around those of communication equipment
and ships. Imports also increased 7.9% YoY in Q2 due
to increased demand for imports of such items as
machinery and metal products.
The trade surplus totaled USD1.4 billion despite unfa-
vorable economic conditions, following an increase of
USD479.0 million in August. Exports increased by
19.6% YoY to USD47.1 billion. It continued to grow on
the strength of key export items such as petroleum
products and automobiles. Meanwhile, imports grew
30.5% to USD45.7 billion. Notably, imports of raw
materials increased centering on shipments of crude oil
(56.7%) and gas (104.0%).
Korean Economic and Financial Review [October 2011]10
TableⅠⅠ.1 Economic Growth Trends
(Unit: %, y.o.y.)
Source: BOK.
2010 2011
2Q 3Q 4Q Year 1Q 2Q
G D P 7.5 4.4 4.76.2
4.2 3.4(q.o.q) (1.4) (0.6) (0.5) (1.3) (0.9)
Consumption 3.4 3.4 3.0 3.9 2.5 2.8
Private 3.5 3.6 2.9 4.1 2.8 3.0
Government 2.9 2.5 3.2 3.0 1.5 2.1
Investment 6.8 6.8 3.4 7.0 △2.2 △1.1
Construction △2.3 △3.1 △2.9 △1.4 △1.9 △6.8
Facilities 30.5 26.6 15.9 25.0 11.7 7.5
Exports 14.5 11.6 15.7 14.5 16.8 9.6
Imports 18.0 14.7 14.2 16.9 10.8 7.9
GNI 5.6 4.5 3.0 5.5 1.8 0.6
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 2.8%
YoY in Q2 2011 from 2.5% YoY in the previous quar-
ter. Private consumption increased modestly by grow-
ing to 3.0% YoY while government consumption also
slightly increased, recording 2.1% growth from a year
ago (Table Ⅰ.1).
Facilities investment declined 1.1% YoY in Q2 2011
with construction investment down 6.8% over the same
period a year ago. Facilities investment’s contribution
to the real GDP growth was △1.2%p in Q2 2011 (Table
Ⅰ.2).
Private Consumption
Private consumption in the national accounts, which
has continued its robust growth of around 3% since Q3
2009, increased by 3.0% YoY in Q2 2011. This resulted
from an improvement in labor market conditions with
increasing employment and real wages (Table Ⅰ.1).
Consumption-related indicators also suggested that the
modest upward pace would continue.
The consumer goods sales index went up by 5.2% YoY
in August, similar to the previous month increasing
5.3% in July. By sector, sales of durable, quasi-durable
showed increases of 12.2%, 4.0%, respectively, in
August compared to 12.6%, 3.9% in last month. Non-
durable goods also went up recording 2.5% in August
(Figure Ⅰ.6).
The service sector also managed positive growth. The
service industry activity index increased 3.8% and
4.8% YoY in July and August 2011 (Table Ⅰ.3).
At the sector level, finance & insurance, transportation,
wholesale & retail, and health & social work sectors
contributed to output growth, while the real estate &
leasing was sluggish due to the real estate downturn,
recording △3.4% YoY in August (Table Ⅰ.3).
Meanwhile, consumer confidence has weakened owing
Macroeconomic Developments 11
TableⅠⅠ.2 Contributions to Real GDP Growth
(Unit: %p)
Source: BOK.
2010 2011
2Q 3Q 4Q Year 1Q 2Q
G D P 7.5 4.4 4.76.2
4.2 3.4(q.o.q) (1.4) (0.6) (0.5) (1.3) (0.9)
Consumption 2.4 2.3 2.0 2.7 1.8 1.8
Private 1.9 1.9 1.5 2.2 1.5 1.5
Government 0.5 0.4 0.5 0.5 0.2 0.3
Investment 2.1 2.0 1.1 2.0 △0.5 △0.3
Construction △0.5 △0.6 △0.6 △0.3 △1.8 △1.2
Facilities 2.7 2.5 1.6 2.3 1.1 0.7
Inventories 4.0 1.2 0.3 2.0 △0.1 0.9
Net Exports △1.0 △1.0 1.3 △0.6 3.1 1.1
FigureⅠⅠ.5 Contributions to Real GDP Growth
Source: BOK.
FigureⅠⅠ.6 Monthly Index of ConsumerGoods Sales
Source: NSO.
to negative domestic and external uncertainties. The
Consumer Expectations Index, a measure of prospects
six months ahead, recorded 78 in September to drop
below the benchmark of 100.
The Consumer Evaluation Index, a measure of current
sentiment compared with those six months earlier,
recorded 64 in September, down 4.0 points from 68 in
August (Figure Ⅰ.7).
Real gross national income (GNI) increased 0.6% YoY
in Q2 2011 and declined by 1.8% over the previous
quarter, reflecting improved terms of trade with steeper
price increases for exports than imports (Figure Ⅰ.8).
Facilities Investment
Facilities investment growth in the national accounts
decreased 1.1% YoY in Q2 2011 reflecting the decrease
of 6.8% YoY in construction investments (Table Ⅰ.1).
But facilities investments, including those for machin-
ery and transport equipment, increased by 7.5%.
Estimated equipment investment growth (current
value) decreased 3.7% in August due to the drop in
machinery, which decreased by 6.0% YoY, in sprite of
the increase in transportation equipment went up by
10.5% YoY (Figure Ⅰ.9).
Domestic machinery orders (current value), a leading
indicator, registered 6.0% growth in August from -
4.4% in July due to the rise in both private and public
sectors.
The Business Survey Index (BSI) produced by the
Bank of Korea, which measures the level of confidence
in the Korean economy, declined to 86 points in Q3
2011, from 91 points in Q1 (Figure Ⅰ.10). Similar
indices produced by the Federation of Korean Indus-
tries and the Korea Chamber of Commerce & Industry
decreased slightly.
Construction investment, a leading indicator, shows the
temporary confusion. Domestic construction orders
Korean Economic and Financial Review [October 2011]12
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.
2011
1Q 2Q Jun. Jul. Aug.
Service Industry Activity 2.7 3.4 3.5 3.8 4.8
Wholesale & Retail 4.0 4.8 4.7 3.1 4.6
Transportation 7.2 3.5 3.0 4.1 4.6
Hotels & Restaurants △0.6 1.9 1.8 2.6 0.9
Telecommunications 3.9 3.4 6.7 4.0 6.0
Finance & Insurance 7.2 8.2 7.3 7.8 10.6
Real Estate & Leasing △17.7△11.5 △4.8 △3.5 △3.4
Business Activities 5.7 5.5 4.9 4.4 1.6
Education 1.1 0.2 0.8 1.9 2.7
Health & Social Work 6.2 5.0 4.8 4.8 5.2
Culture & Sporting 2.4 1.2 1.4 3.1 1.1
jumped by 75.4% growth in August 2011 influenced by
the rise in both private sector (103.9% YoY) and public
sector (13.4% YoY). Meanwhile, Construction com-
pleted (current value) decreased by 3.2% in August, a
slower pace of decrease compared to the previous
month from △8.8% in July, due to the drop in private
sectors (Figure Ⅰ.11).
The Bank of Korea, which adopted an expansionary
monetary policy from October 2008 raised the Base
Rate in January from 2.5% to 2.75%, in March from
2.75% to 3.0%, and again in July from 3.0% to 3.25%
due to concerns about consumer price inflation. Look-
ing ahead, the readjustment of bank interest rates will
do what is needed to bring about the continuation of the
recent improving pattern of economic movements and
financial market stabilization (Figure Ⅰ.12).
1.2 External Demand and theBalance of Payments
Sungwook Park (swpark@kif.re.kr)
Global growth has weakened in most advanced economies
and become more uneven. Fiscal and financial uncer-
tainties still remain unsettled and downside risks are
growing.
The US economy increased at an annual rate of 1.3%
QoQ in Q2 2011 from an increase of 0.4% QoQ in Q1
2011. The increase of the US economy in Q2 2011 pri-
marily reflected positive contributions from federal
government spending and exports. Federal government
expenditures increased 1.9% QoQ in Q2 2011, follow-
ing a decrease of 9.4% QoQ in Q1 2011. Personal con-
sumption expenditures increased 0.7% QoQ in Q2
2011, following an increase of 2.1% QoQ in Q1 2011.
Exports of goods & services increased 3.6% QoQ in Q2
2011 from an increase of 7.9% QoQ in Q1 2011.
Imports of goods & services increased 1.4% QoQ in Q2
2011, following an increase of 8.3% QoQ in Q1 2011
respectively.
Macroeconomic Developments 13
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 Rate andBOK Base Rate
Source: BOK.
In contrast, State and local government expenditures
decreased △2.8% QoQ in Q2 2011, following a
decrease of △3.4% QoQ in Q1 2011. And also the US
unemployment rate held at 9.1% in August of 2011, the
same as in July of 2011.
The eurozone economy grew 0.2% QoQ in Q2 2011
from an increase of 0.8% QoQ in Q1 2011. Economic
growth in the eurozone continued its downward trend
caused by the sovereign debt problems in southern
europe. Eurozone consumption expenditure decreased
△0.2% QoQ in Q2 2011, while gross fixed capital for-
mation increased 0.2% QoQ in Q2 2011. Exports rose
by 1.0% QoQ in the eurozone. Imports grew by 0.5%
QoQ in the eurozone in Q2 2011. Meanwhile, eurozone
unemployment rate was still high at 10.0% in August of
2011.
Japan’s GDP decreased at an annual pace of △2.1%
QoQ in Q2 2011. The Japanese economy seems to be
gradually getting out of the impact of the March earth-
quake and tsunami. Confidence has also picked up, but
uncertainties still remain. Private consumption was
unchanged QoQ in Q2 2011 from a decrease of △0.6%
QoQ in Q1 2011. Private residential investment
decreased △1.8% QoQ in Q2 2011, compared with an
increase of 0.2% QoQ in Q1 2011. Public demand
recorded 1.2% QoQ in Q2 2011, compared with an
increase of 0.6% QoQ in Q1 2011. Exports of goods &
services decreased △4.9% QoQ in Q2 2011, down
from 0.0% QoQ in Q1 2011. The unemployment rate
recorded 4.3% in August of 2011, slightly down from
4.7% in July of 2011.
The Chinese economy grew 9.5% YoY in Q2 2011,
down from an increase of 9.7% YoY in Q1 2011. The
Chinese economy has maintained a steady growth rate
for both domestic demand and exports even while infla-
tion pressures remain high. Total retail sales of con-
sumer goods increased 16.8% YoY in Q2 2011. Invest-
ment in fixed assets rose 25.6% YoY during the same
period. China’s consumer price index recorded 6.4%
YoY in Q2 2011. Imports and exports increased YoY by
17.9% and 19.3%, respectively, in Q2 2011.
Korean Economic and Financial Review [October 2011]14
TableⅠⅠ.4 Major Countries’ Economic Growth(Unit: %, q.o.q.)
Note: 1) QoQ, Seasonally Adjusted Annual Rate2) QoQ, Seasonally Adjusted3) YoY
Source: Bloomberg.
2009 20102010 2011
Q3 Q4 Q1 Q2
US1) △2.6 2.9 2.5 2.3 0.4 1.3
Japan1) 6.3 △2.9 4.0 △2.4 △3.7 △2.1
China3) 10.7 9.8 9.6 9.8 9.7 9.5
EU2) 0.3 0.3 0.4 0.3 0.8 0.2
Germany3) △2.0 3.8 3.9 3.8 4.6 2.8
France1) 2.4 1.4 1.7 1.3 3.7 0.0
Sweden1) 2.3 6.5 8.3 4.9 3.1 3.6
Greece2) 0.7 △2.8 △1.6 △2.8 0.2 -
TableⅠⅠ.5 Major Countries’ UnemploymentRates (Unit: %)
Source: Bloomberg.
2009 20102010 2011
Q3 Q4 Q1 Q2 Aug.
US 9.3 9.6 9.6 9.6 8.9 9.1 9.1
Japan 5.2 4.9 5.0 4.9 4.6 4.5 4.3
Eurozone 10.1 10.0 10.2 10.0 9.9 9.9 10.0
TableⅠⅠ.6 Balance of Payments(Unit: 100 mil. USD)
Source: BOK.
2009 20102010 2011
Q3 Q4 Q1 Q2 July~August
Current Account 327.9 282.1 99.3 91.6 26.1 54.9 41.8
Goods 378.7 419.0 125.4 123.4 58.4 76.6 52.1Exports(f.o.b.) 3,581.9 4,642.9 1,182.6 1,270.9 1,276.9 1,427.2 943.5
Imports(f.o.b.) 3,203.2 4,223.8 1,057.2 1,147.5 1,218.5 1,350.6 891.4
Services △66.4 △112.3 △29.6 △22.0 △25.4 △8.0 △12.7
Transport 52.4 92.5 24.6 31.9 25.1 23.1 17.8
Travel △52.2 △79.0 △27.0 △18.5 △22.4 △22.7 △17.1
Income 22.8 7.7 13.0 △0.7 3.9 △8.3 7.7
Current Transfers △7.1 △32.3 △9.5 △9.1 △10.8 △5.5 △5.4
Exports (f.o.b.) 3,653.3 4,663.8 1,163.2 1,287.5 1,310.0 1,427.4 951.2
(%, y.o.y.) (△13.9) (28.3) (22.7) (23.8) (29.6) (18.7) (23.7)
Imports (c.i.f.) 3,230.8 4,252.1 1,057.0 1,157.3 1,236.7 1,343.6 897.5
(%, y.o.y.) (△25.8) (△31.6) (24.6) (24.6) (26.0) (27.2) (26.9)
Korea’s current account surplus recorded USD5.5 bil-
lion in Q2 2011, up from USD2.6 billion in Q1 2011.
More recently, the current account surplus recorded
USD4.2 billion from July to August of 2011.
The goods account surplus recorded USD7.7 billion in
Q2 2011 from USD5.8 billion in Q1 2011.
The services account deficit stood at △USD0.8 billion
in Q2 2011 from△USD2.5 billion in Q1 2011. In par-
ticular, travel expenses recorded a deficit of △USD2.3
billion in Q2 2011. The services account deficit
recorded △USD1.3 billion from July to August of
2011 mainly due to the gradually recovery of travel to
Japan after the March earthquake.
The income account shifted to a deficit of △USD0.8
billion in Q2 2011 from a surplus of USD0.4 billion in
Q1 2011. Meanwhile, the current transfers account
deficit recorded △USD0.6 billion during Q2 2011
from a deficit of △USD1.1 billion deficit in Q1 2011.
Exports (customs-cleared basis) rose 18.7% YoY in Q2
2011 from an increase of 29.6% YoY in Q1 2011.
Imports increased 27.2% YoY in Q2 2011 from an
increase of 26.0% YoY in Q1 2011.
Export volume in most key industries grew signifi-
cantly, although the growth rates slowed somewhat in
Q2 2011. In particular, petrochemicals, automobile
parts, machinery, steel, automobiles, textiles, and ves-
sels have continued to expand. Wireless communica-
tion equipment also apparently rose 22.7% in Q2 2011
compared to previous quarter. However, home appli-
ances and semiconductors decreased △1.8% & △3.2%
YoY in Q2 2011 from an increase of 10.9% & 14.2%
YoY in Q1 2011, respectively.
Growth rates of Korea’s exports to major trading part-
ners generally increased in Q2 2011 except those to
Latin America. Exports to China, Korea's top overseas
market, grew 14.3% YoY in Q2 2011. Exports to
ASEAN countries and the US rose 32.7% and 17.6%
YoY, respectively, in Q2 2011. In the meantime, ship-
ping abroad to the EU slowed sharply to 2.5% YoY in
Macroeconomic Developments 15
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).
2010 2011
Q1 Q2 Q3 Q4 Q1 Q2
Petroleum & 6,289 7,956 8,050 9,236 10,697 13,765 9,904Derivatives (44.0) (54.1) (24.0) (33.0) (70.1) (73.0) (86.9)
Petro- 8,542 9,080 8,712 9,381 10,908 11,603 8,238chemicals (58.3) (33.3) (14.8) (22.3) (27.7) (27.8) (40.9)Automobile 4,164 4,605 4,686 5,508 5,389 5,652 4,056
Parts (107.3) (74.7) (49.3) (40.2) (29.4) (22.7) (29.0)
Machinery7,774 9,194 8,911 10,223 10,734 11,504 7,430(33.2) (43.7) (25.2) (36.3) (38.1) (25.1) (23.4)
Steel5,877 7,165 7,385 8,449 8,407 9,169 7,173(14.8) (14.7) (30.3) (40.9) (43.1) (28.0) (45.3)
Automobiles7,442 9,415 8,375 10,179 9,749 11,882 7,094(51.2) (62.0) (28.0) (25.1) (31.0) (26.2) (26.4)
Textiles2,930 3,649 3,471 3,849 3,672 4,296 2,647(22.7) (19.8) (13.8) (22.2) (25.3) (17.7) (12.1)
Wireless 6,631 6,129 6,540 8,321 7,059 7,521 4,594Communication (△10.3) (△22.9) (△18.6) (9.3) (6.4) (22.7) (9.5)Equipment
Liquid 6,715 7,577 8,250 7,363 6,660 7,003 4,474Devices (64.1) (34.8) (22.3) (5.6) (△0.8) (△7.6) (△21.3)
Home 3,008 3,425 3,289 3,093 3,337 3,365 2,419Appliances (42.5) (35.2) (20.7) (15.0) (10.9) (△1.8) (8.4)
Vessels9,894 14,674 11,408 13,136 16,358 15,539 9,231(△8.4) (10.1) (20.4) (13.9) (65.3) (5.9) (36.8)
Semi- 10,692 12,942 14,132 12,941 12,215 12,530 8,155conductors (120.7) (84.1) (60.8) (24.7) (14.2) (△3.2) (△12.9)
Computers 2,235 2,268 2,024 2,589 2,121 2,110 1,641(33.7) (19.1) (△1.9) (9.1) (△5.1) (△7.0) (25.4)
TableⅠⅠ.7 Monthly Exports and Imports(Unit: 100 mil. USD, y.o.y %)
Source: Ministry of Knowledge Economy.
2011
Apr. May Jun. Jul. Aug. Sep.
Total 485.5 474.2 467.5 491.8 459.4 471.2
Growth 23.5 21.9 11.2 21.7 25.9 19.6Rate
Daily 20.7 21.6 20.3 20.9 19.1 21.4Exports
Total 441.8 453.1 448.9 442.9 454.6 456.8Growth 24.4 30.0 27.3 25.0 28.9 30.5Rate
Daily 18.8 20.6 19.5 18.8 18.9 20.8Imports
Trade 43.6 21.1 18.6 48.9 4.8 14.4Balance
Exports
Imports
July~Aug.
Q2 2011, reflecting Europe’s fiscal woes. Exports to the
Middle East recorded 10.8% YoY or USD8.4 billion
during the same period.
2. Aggregate Supply
Hyoung-Seok Lim (hslim@kif.re.kr)
Potential Growth
The potential growth measured by smoothing (HP-Fil-
tering) real GDP growth rates has been still hovering
around 3%. This means real GDP growth can attain 3%
without inflation or other adverse effects by fully utiliz-
ing its resources. Recently, however, it has increased
slightly. This was mainly because real GDP growth has
been high since the 2009 on the strength of the world
economic recovery.
Potential growth, in a long-term perspective, peaked at
10.8% during 1986 and 1987. Since then, the rate has
been in a steady decline. The major factor behind the
downward trend is population changes like the low
birthrate and a rapidly aging demographic. 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 TFP
(Total Factor Productivity) 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).
Korean Economic and Financial Review [October 2011]16
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.
2010 2011
Q1 Q2 Q3 Q4 Q1 Q2
China 26,562 29,068 29,205 32,003 31,128 33,237 23,596(61.0) (38.9) (22.6) (25.8) (17.2) (14.3) (21.1)
Japan 3,953 6,824 7,277 8,123 8,897 10,037 6,916(28.6) (33.2) (24.6) (31.4) (49.5) (47.1) (41.2)
EU 11,549 14,683 12,904 14,371 15,556 15,053 8,414(13.5) (22.1) (19.7) (5.5) (34.7) (2.5) (△3.6)
ASEAN 11,618 13,796 13,003 14,779 16,202 18,306 12,849(46.1) (39.2) (17.7) (22.4) (39.5) (32.7) (51.8)
US 10,537 12,963 12,741 13,576 12,601 15,243 8,983(26.8) (36.6) (29.8) (35.3) (19.6) (17.6) (4.6)
Latin 7,692 9,862 9,659 8,974 9,713 9,771 7,167America (39.5) (67.8) (24.9) (17.4) (26.3) (△0.9) (19.1)Middle 5,719 7,604 6,680 8,366 7,551 8,428 4,981East (10.6) (14.7) (13.4) (31.7) (32.0) (10.8) (8.4)
FigureⅠⅠ.14 Total Fertility Rate
Source: NSO.
July~Aug.
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-
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
Macroeconomic Developments 17
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.
FigureⅠⅠ.17 Population Growth Rates(Projections)
Source: NSO.
improved over time, albeit at a diminishing rate (FigureⅠ.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 turned to increase in August
since January 2010. Also the employment of those aged
30~59 has been on the rise and employment of those
aged 60 and over has continued to increase.
On the other hand, although the growth of youth
employment was positive since August, that figure was
low level and it is uncertain whether it will last or not.
Therefore structural unemployment issues is remained
a lurking threat to the Korean economy’s potential
growth (Figure Ⅰ.19).
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.
From a long-run perspective, a slowdown in the rate of
capital accumulation usually occurs in a developing
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).
Korean Economic and Financial Review [October 2011]18
FigureⅠⅠ.20 Capital-Output Ratio
Source: BOK.
FigureⅠⅠ.19 Employment Changes by Age
Source: NSO.
FigureⅠⅠ.18 Labor Force Growth andAverage Years of Schooling
Source: NSO, KIF.
B. Inflation
Kyoobok Lee (leekb@kif.re.kr)
1. Oil and Import Prices
Crude oil Prices
Crude oil prices (including WTI, Brent and Dubai)
were volatile in Q3 2011, mainly affected by the global
economic & financial market conditions and crude oil
supply.
In July, crude oil prices increased as oil products from
North Sea was expected to decrease in August because
of the maintenance of the major oil fields like Brent,
Oseberg and Ekofisk. Also, weak dollar made the oil
prices increase. The dollar index, which is a measure of
the value of the US dollar relative to a basket of foreign
currencies including euro, Japanese yen, pound ster-
ling, Canadian dollar, Swedish krona and Swiss franc,
decreased 0.5% at the end of July from June.
Meanwhile, early-August, crude oil prices deceased
amid growing concerns over government debt and the
likely impact on the global economy, and dubai oil fell
to $103.7 a barrel from $116.0 a barrel as of the end of
July. On the other hand, from mid-August to early-Sep-
tember, crude oil prices increased from expectations of
the US economic stimulation. However, crude oil
prices fell again mainly due to the strong dollar and
concerns on the global economic slowdown affected by
European sovereign debt crisis.
As economic outlook became more uncertain, non-
commercial crude oil net purchase also decreased. In
Q3, those decreased 29%, or 1.9 million contracts,
compared to 2.7 million contracts of Q2 2011.
Consequently, recent Brent and Dubai oil prices were
hovering between USD101 and USD105 a barrel and
WTI was around $80 a barrel.
Macroeconomic Developments 19
FigureⅠⅠ.21 Oil Prices
Source: Bloomberg.
FigureⅠⅠ.22 Non-commercial Crude Oil NetPurchase
Source: Bloomberg.
Import Prices
Although prices of capital goods decreased 4.7% y.o.y.
amid the price of intermediate materials rising by just
5.1% y.o.y. in Q3, import prices of all items (won-
denominated) increased by 11.3% y.o.y. during the
same periods as import prices of raw materials (won-
denominated) increased 25.5% y.o.y..
Among raw materials prices, those for agricultural
products, forest product, and mineral fuel increased by
16.3%, 22.7%, and 28.9% y.o.y. respectively from July
to September.
On the other hand, US dollar-denominated import
prices rose by 21.6% y.o.y. in Q3, which was higher
than won-denominated import prices. Raw materials
and semi-finished prices denominated in USD each
rose by 37.2% and 14.9% y.o.y. Prices of capital and
consumer goods also increased by 4.1% and 8.4% y.o.y.
during the same period.
These gaps between won-denominated import prices
and dollar-denominated import prices were attributed
to y.o.y. appreciation of the Korea won (KRW) against
the dollar (USD) by 8.2%. The KRW/USD exchange
rate averaged KRW1,086 from July to September this
year compared to KRW1,183 during the same period in
2010.
Similarly, while US dollar-denominated export prices
rose by 11.6% from July to September, those denomi-
nated in KRW increased by only 2.1% y.o.y..
Korean Economic and Financial Review [October 2011]20
FigureⅠⅠ.23 Import and Export Price Indices(Won-denominated)
Source: BOK.
FigureⅠⅠ.24 Won-denominated ImportedPrices
Source: BOK.
2. Domestic Inflation
Consumer prices’ growth exceeding BOK’s inflation
target of 2~4% since 2011 increased compared to Q2.
Moreover, producer prices’ growth was above 6% since
April 2011.
Producer Prices
In Q3 2011, producer prices rose by 6.2% y.o.y., 0.2%p
lower than in Q2, as the growth of goods prices
decreased to 7.7% from 7.9% in Q2 and those of ser-
vice prices decreased to 1.9% from 2.2% in Q2. Mean-
while electric power, water & gas supply increased
5.7% y.o.y., compared to 4.6% in Q2 2011.
Specifically, from July and September, prices in agri-
cultural and forest & marine products increased 5.1%,
lower than the 6.7% in Q2. Unseasonable weather in
July and August raised their prices by 12.3% before
falling by 7.1% in September. On the other hand, prices
of industrial products rose by 8.1% y.o.y., lower than
the 8.2% in Q2, but still high. Among industrial prod-
ucts, prices in petroleum & derivatives increased
22.9% during the same periods mainly due to the
increase in the price of crude oil.
Prices in services lagged behind the industrials,
increasing by only 1.9% y.o.y.. Prices in the financial
services, including brokerage fees and premiums, rose
by 3.2%, the prices in professional and scientific &
technical services, including architectural design, engi-
neering and fees for CPAs and tax accountants, rose by
3.0% and prices in transportation service increased by
2.8%. Meanwhile, the price of leasing & renting fell by
0.5% y.o.y. and telecommunication service prices
decreased by 0.8%.
Consumer Prices
The Consumer Price Index (CPI) rose 4.8% y.o.y. in
Q3 2011, higher than the 4.2% increase in Q2 2011.
More specifically, in Q3, consumer prices for agricul-
Macroeconomic Developments 21
FigureⅠⅠ.25 CPI, PPI, and Core Inflation
Source: NSO.
TableⅠⅠ.11 CPI and PPI
(Unit: %, y.o.y.)
Source: BOK.
2011
1Q 2Q 3Q Jul. Aug. Sep.
CPI 4.5 4.2 4.8 4.7 5.3 4.3
Agriculture and 16.6 8.1 8.7 11.2 13.3 2.3Fishing
Industrial 5.0 5.8 7.1 6.3 7.1 7.7
Service 2.4 2.7 3.0 3.0 3.1 2.8
PPI 6.7 6.4 6.2 6.5 6.6 5.7
Agriculture, Forestry, 21.0 6.7 5.1 12.1 12.5 △7.1and Fishing
Industrial 7.9 8.2 8.1 7.9 8.0 8.2
Services 1.9 2.2 1.9 2.2 1.9 1.6
ture, forestry and fishing increased by 8.7% and those
of industrial products by 7.1%.
The increase in CPI for basic necessities rose to 4.6% in
Q3 from 4.0% in Q2. Core CPI, excluding food and
fuel, also rose to 3.9% in Q3, up 0.4%p from the previ-
ous quarter.
On the other hand, in September, CPI growth slowed to
4.3% after rising to 5.3% in August, mainly due to the
base effect and the slower rate of increase for agricul-
tural, forestry and fishing products.
Real Wages
In Q2 2011, real wages for all industries fell by an aver-
age of 2.8% y.o.y. although nominal wages increased
1.4%.
While real wages of the construction and the food &
lodging sector rose 12.8%, 10.4% y.o.y. respectively,
those in manufacturing and transport fell 3.1%, 3.0%
y.o.y., respectively. Moreover, real wages of education
services and real estate sectors decreased by 10.7%,
7.8% y.o.y. respectively.
Korean Economic and Financial Review [October 2011]22
FigureⅠⅠ.27 Real Wage Growth
Source: Ministry of Employment and Labor (MoEL),
BOK, KIF.
FigureⅠⅠ.26 Contributions to Consumer PriceInflation
Source: NSO, KIF.
C. Macroeconomic Outlook for2011
1. Global Economy and Balance ofPayments
Sungwook Park (swpark@kif.re.kr)
According to a recent IMF forecast, global activity in
2011 was lower than previously expected. The world
economy is expected to grow 4.0% in 2011 with
advanced economies growing 1.6% and emerging and
developing economies 6.4% in 2011. Advanced
economies are to slow down noticeably due to Europe’s
fiscal crisis and slower-than-expected recovery of the
US economy.
The US economy is expected to grow by 1.5% in 2011,
lower than 3.0% it did in 2010. Growth could suffer fur-
ther if the temporary payroll tax cuts and increased
unemployment insurance are not extended into 2012.
Overall, the speed of recovery is expected to be slow
for a considerable period.
The IMF forecasts 9.5% growth for the Chinese econ-
omy in 2011, down from 10.3% in 2010. The Chinese
economy has shown signs of cooling down somewhat
due to the sluggish demand from advanced economies
and tightened monetary policy. Nevertheless, the
chance of a hard-landing seems to be remote because
the Chinese government has strong policy measures to
cope with adverse economic shocks and willingness to
support the economy, if needed, before the leadership
change next year.
The Japanese economy is expected to contract by
△0.5% in 2011. Japan is slowly recovering from the
March earthquake, but high levels of public debt and
upward pressure on its currency is expected to hold
back a rapid recovery.
The eurozone is forecast to grow 1.6% in 2011. The
ongoing financial instability will be a drag on economic
Macroeconomic Developments 23
TableⅠⅠ.12 Economic Outlook for MajorTrade Partners
Source: International Monetary Fund, World EconomicOutlook (IMF WEO) (Sept. 2011).
(Unit: annualized GDP y.o.y. %)
2010Projections
2011 2012
World 5.1 4.0 4.0
Advanced 3.1 1.6 1.9Countries
US 3.0 1.5 1.8
China 10.3 9.5 9.0
Japan 4.0 △0.5 2.3
Euro Area 1.8 1.6 1.1
TableⅠⅠ.13 Economic Outlook for OtherCountries
Source: IMF WEO (Sept. 2011).
(Unit: %)
Countries 2010Projections
2011 2012
Emerging and7.3 6.4 6.1Developing Economies
Commonwealth ofIndependent States 4.6 4.6 4.4
Developing Asia 9.5 8.2 8.0
Latin America and the 6.1 4.5 4.0Caribbean
Middle East and North Africa
4.4 4.0 3.6
Sub-Saharan Africa 5.4 5.2 5.8
Central and 4.5 4.3 2.7Eastern Europe
activity through lower consumer and corporate confi-
dence and financing.
In emerging & developing economies, the growth is
expected to be 6.4% in 2011. The slowdown in
advanced economies will gradually dampen external
demand for their exports.
In Korea, the balance of payments is expected to regis-
ter a current account surplus of USD15.4 billion in
2011, lower than the USD28.2 billion recorded a year
earlier. Growth in exports and imports is expected to
increase by 20.1% and 24.7% for the year.
2. Economic Growth
Myong-Hwal Lee (mhlee@kif.re.kr)
The Korean economy has continued its growth trend in
spite of domestic and external uncertainties. On the
production side, manufacturing and services increased
by 8.4% and 2.7% YoY in H1 2011. On the expenditure
side, private consumption and exports have continued
robust growth. Meanwhile, employment conditions
also have remained on track for improvement. The
number of people employed has continued to increase
by around 300~400 thousand persons YoY since Octo-
ber last year, and the unemployment rate declined to
3.4% in Q2 from 4.2% in Q1 2011.
Meanwhile, the upward trend in CCI and CLI has been
sluggish as a number of potentially negative domestic
and external uncertainties appeared in Q2. The cyclical
component of the Composite Coincident Index (CCI),
which reflects the current economic situation, remained
unchanged from the previous month, registering 100.9
in August 2011. The 12-month smoothed changes in
the Composite Leading Index (CLI), which predicts
turning points in the business cycle, registered 2.0% in
August, same as the previous month.
The global economy has weakened and downside risks
are growing. Although the emerging market economies
have continued good performances, the recovery in
Korean Economic and Financial Review [October 2011]24
TableⅠⅠ.14 Balance of Payments Forecast inKorea
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 81 73 154
Goods 419 135 131 266
Service·Income·△137 △54 △58 △112
Current Transfers
Exports (f.o.b.) 4,664 2,737 2,848 5,601(Growth, %)1) (28.3) (23.7) (16.2) (20.1)
Imports (c.i.f.) 4,252 2,581 2,722 5,303(Growth, %)1) (31.6) (26.6) (22.9) (24.7)
Won/Dollar 1,156 1,102 1,120 1,111Exchange Rate2)
FigureⅠⅠ.28 Cyclical Component of CCI and CLI
Source: NSO.
FigureⅠⅠ.29 Contributions to HouseholdConsumption Expenditures
Source: BOK.
major advanced economies, including the US and
Europe has exhibited signs of further weakening that
will put downward pressure on growth. In September
2011, the IMF projected that the global economy will
grow by 4.0% in 2011, a drop of 0.3%p from the July
forecast.
The risk factors are growing concerns over the global
economies that will have adverse effects on the world
economic outlook. The possibility of a double dip
recession in the US is a cause of the delayed recovery in
the global economy. In addition, the contagion of the
euro zone’s sovereign debt crisis, which is spreading to
Spain and Italy, has resurfaced repeatedly as a risk fac-
tor in the global financial markets. Finally, in China,
concerns about inflation have set in motion the process
of policy tightening that may be bring about a hard
landing.
The upward trend in inflation, which recorded 5.3%
YoY in August, is the main concern for Korea’s econ-
omy. However, the trend of rising prices is expected to
slow down after H2 this year due to stabilization in oil
prices. Household debt, which is in excess of KRW800
trillion, is one of the serious potential risk factors. The
problems surrounding real estate PF loans and mutual
savings banks may add to the uncertainties in financial
markets. Finally, foreign capital inflows and outflows
have been so volatile that of foreign currency liquidity
is concerned.
Gross Domestic Product
The Korean economy is expected to continue its recov-
ery, but it will probably weaken in H2 2011. Exports, in
particular, have contributed considerably to the growth,
increasing by 13.0% in H1. However, the upward trend
in exports will likely moderate slightly in H2 because
the global economy has shown signs of abating while
and downside risks are growing.
We forecast GDP growth rate at 3.9% YoY this year, a
drop of 0.5%p from the August forecast, led by the
expansion in export growth and private consumption.
Growth is also forecasted to be 3.9% YoY in H2 this
year.
Macroeconomic Developments 25
FigureⅠⅠ.30 Rate of Change in Inventories
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 3.8 3.9 3.9
Consumption 4.6 3.2 3.9 2.6 2.6 2.6
Private 5.1 3.3 4.1 2.9 2.4 2.6
Investment 9.3 5.0 7.0 △1.6 2.2 0.4
Construction 0.4 △3.0 △1.4 △9.0 △0.3 △4.4
Facilities 29.8 21.0 25.0 9.4 5.4 7.3
Exports 15.5 13.7 14.5 13.0 8.9 10.8
Imports 19.7 14.5 16.9 9.3 10.0 9.7
FigureⅠⅠ.31 Consumption Indices
Source: NSO.
Private consumption is expected to increase by 2.6% in
2011 and 2.4% in H2 with increase in employment and
real wages. However, the declines in real purchasing
power and consumer sentiment due to increase in infla-
tion and the growing household debt burden as well as a
decrease in stock price due to global fiscal crisis will
restrict the increase in private consumption.
Facilities investment is also forecasted to increase by
7.3% in 2011 and 5.4% in H2. However, the recovery
trend is expected to be slightly limited because of the
downside risk factors in facilities investment, such as
global and domestic economic uncertainties and signs
of slowdown in global economic growth.
Construction investment, which decreased by 9.0%
YoY in H1, is forecasted to decline by 4.4% in 2011 for
lack of funding and the non-performance of PF loans.
In the H2, it is anticipated to record △0.3% mainly due
to SOC investment in the public sector.
3. Inflation
Kyoobok Lee (leekb@kif.re.kr)
Inflation, as measured by changes in the CPI, is forecast
to be 4.2% in 2H 2011. Even though it recorded 4.8% in
Q3, it is expected to fall to mid △3% level in Q4.
This is mainly because there will be base effect. Oil and
raw material prices have increased rapidly since Q4
2010, so on a y.o.y basis the growth rate for oil and raw
material prices will likely fall. Furthermore, prices for
agricultural and forest & marine products are expected
to stabilize, notwithstanding any unexpected unsea-
sonal weather.
However, the slowdown in inflation will be limited
because the second-round effect on inflation was led
with businesses passing on higher costs and KRW
might depreciate against the USD if uncertainty over
the global economy persists.
Korean Economic and Financial Review [October 2011]26
FigureⅠⅠ.32 Estimated Index of EquipmentInvestment
Source: NSO.
TableⅠⅠ.16 Inflation Forecasts(Unit: %, y.o.y.)
20102011
H1 H2 Year
CPI 2.9 4.3 4.2 4.3
Notes: Figures are 2011 forecasts.
FigureⅠⅠ.33 Contributions to ConstructionInvestment Growth
Source: BOK.
Financial Markets and Industries 27
A. Asset Prices
1. Recent Trends
Kyoobok Lee (leekb@kif.re.kr)
Interest Rates
In Q3 2011, money market rates were hovered as the
Bank of Korea has maintained the base rate at 3.25%
since June 2011. In July, it was expected that the BOK
would raise the base rates to respond to the inflationary
pressures and the run-up in international commodity
prices. But the rate remained unchanged as concerns
over the global economic slowdown was increasing
and international financial markets uncertainty deepen-
ing. Hence the short-term market rates, which are influ-
enced by the base rate, also remained largely
unchanged.
Consequently, in mid-October, the 91-day CD rates and
the 91-day CP rates hovered around 3.58% and 3.71%
respectively.
On the other hand, long-term market interest rates,
influenced by both the upward adjustment in the base
rate and external risks, fell markedly since August.
External risks, such as sovereign debt concerns in the
For the remainder of the year the Bank of Korea is expected to leave the base rate unchanged dueto heightened risks in the European fiscal crisis. The Korean Won is expected to hover at the cur-rent level of 1,100 amid higher volatility and we forecast an annual average of 1,111 in 2011. In thestock market, both downside and upside risks co-exist, and therefore we expect range trading untilthe year end. Growth opportunities for Korean banks are expected to show a steady increase in Q32011. Improvements in economic conditions and banks’ efforts to expand loans will offer a betterchance for growth. In Q4 2011, both the assets and profitability of securities firms are expected todecrease owing to uncertainty. Growth in total assets and premium income of both the life and non-life insurance companies will continue in Q3, while uncertainties in the financial markets will limitany significant increase.
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.
euro zone and the US economic slump, forced the rates
to fall. As well as those of Korean Treasury bonds, the
majority of the government bond yields of the major
economies continued to fall during Q3.
As a result, 3-yr treasury bond yields, which peaked at
3.85% at the beginning of August decreased to 3.31%
in mid-September. It rose recently above 3.4%.
Corporate bond yields moved in tandem with treasury
yields. After corporate bond yields for AA- 3yr paper
increased to 4.59% in the beginning of August before
falling to 4.1% on September 14, 2011. It rose recently
over 4.2%. Consequently, the credit spreads on corpo-
rate bonds sustained the level of 70~80bps over trea-
surys.
Exchange Rates
Sungwook Park (swpark@kif.re.kr)
In Q3 2011, the Korean currency (KRW) depreciated
△8.6% against the US dollar (USD) from the end of
Q2 2011. The depreciation of the KRW was mainly due
to eurozone fiscal crisis. The turbulence in the interna-
tional financial markets has made foreign investors
more risk averse and gave cause to withdraw from
emerging markets like Korea. Consequently, the
KRW/USD exchange rate stood at KRW1,179.5 at the
end of September 2011.
The EUR fell by △6.2% to USD1.3576 at the end of
Q3 from USD1.4474 at the end of Q2 2011. The depre-
ciation reflected the anxiety about eurozone fiscal cri-
sis. Concerns about increased default risk of Greece
sovereign debt, downgrading of Itay’s credit rate, and
rumors about liquidity shortage of French banks were
among those that pushed the value of the EUR lower.
The JPY appreciated 5.2% to USD76.76 by the end of
Q3 from USD80.72 at the end of Q2 2011. Despite the
downgrade of Japanese sovereign debt by Moody’s, the
JPY against the USD appreciated mainly due to height-
ened safe-haven demand in the volatile global financial
markets.
Korean Economic and Financial Review [October 2011]28
Figure ⅡⅡ.5 Dollar/Euro Exchange Rate andYen/Dollar Exchange Rate
Source: BOK.
Figure ⅡⅡ.3 Major Countries’ Treasury BondRates (5yr)
Source: Bloomberg.
Figure ⅡⅡ.4 Won/Dollar Exchange Rate andWon/Yen Exchange Rate
Source: BOK.
Stock Prices
Hyungjoon (Ray) Lim (hjlim@kif.re.kr)
The Korea Composite Index (KOSPI) ended Q3 2011
at 1,770 points, down 331 points from the end of the
previous quarter. In July, the KOSPI continued the
upward trend from the last quarter climbing 2,181
points on the 7th. But in early August the KOSPI
plunged reacting to the news of worse than expected
US economic indicators and of the downgrade of the
US sovereign credit rating by Standard & Poors.
Since then fears about the global economic recession
stemming from a stagnant the US growth and about the
fiscal crisis in the euro zone continued putting down-
ward pressure on the KOSPI. The KOSPI fell to 1,653
points on September 26 as the Federal Open Market
Committee (FOMC) result and the downgrade of credit
ratings of some global banks caught the market by sur-
prise.
In Q4 2011, the KOSPI is forecasted to have balanced
upside and downside risks. But uncertainty surround-
ing the euro zone and the execution of ‘Operation
Twist’ by the Federal Reserve would bring about
volatility in the stock market.
Foreign investors sold a net of KRW4,544 billion in
equities in Q3 2011. In July, foreign investors pur-
chased equities expecting the fiscal crisis in the euro
zone to moderate. But with concerns over the global
economic recession and the fiscal crisis in the euro zone
resurfacing, foreign investors turned net sellers of equi-
ties in August. On the other hand, domestic institutional
investors purchased a net of KRW4,395 billion as pen-
sion funds raised their net buying extensively in
August. Retail investors made a net purchase of
KRW149 billion in equities in the quarter.
Equity issuances in the KOSPI and KOSDAQ during
the first two months of Q3 amounted to KRW239 bil-
lion on a monthly average basis, down 81% from the
previous quarter (Table Ⅱ.2). This resulted from sea-
Financial Markets and Industries 29
Figure ⅡⅡ.6 KOSPI and Total Trading Volume
Source: Korea Stock Exchange (KSE).
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
Q2 Q3 Q4 Q1 Q2
Corporate 11,552 10,320 10,070 11,310 13,228 9,452Financing (A)1)
CorporateSecurities 725 708 1,092 978 1,241 239Offerings (B)2)
•Initial Public 213 317 218 314 328 167Offerings•Rights 512 391 874 769 914 72
Offerings
B/A 6.3 6.9 10.8 8.6 9.4 2.5
Q3(Jul.~Aug.)
Table ⅡⅡ.1 Stock Investment Flows(Unit: bil. won)
Note: 1) Including pension funds.Source: KSE.
2010 2011
Q2 Q3 Q4 Q1 Q2 Q3
Securities 43 434 877 605 1,030 △81Cos.
Insurance 559 453 △860 △769 △234 △424Cos.
ITCs △4,110△5,607△6,362△1,552 △3,257 1,362
Banks 258 △165 △603 317 △167 △1,949
Other1) 418 1,681 △200 2,804 △169 5,487
All △2,832△3,204△7,147 1,406 △2,797 4,395Institutions
Individuals 3,237 △3,425△2,078 639 2,941 149
Foreign △404 6,629 9,225 △2,045 △144 △4,544Investors
sonal causes such as semiannual settlement and from
deferring IPO’s due to global financial market instabil-
ity.
2. Outlook for 2011
Interest Rates
Kyoobok Lee (leekb@kif.re.kr)
The Bank of Korea is expected to leave the base rate
unchanged until the end of 2011.
Market rates are therefore expected to be stable around
the current level (Treasury yields: mid 3%, corporate
bond yields rated AA-: around 4.3%). In this case,
Treasury yields for 3-yr notes and 3-yr corporate bond
yields rated AA- are expected to record to be in the
3.5% and 4.3% range in H2 2011.
Exchange Rate
Sungwook Park (swpark@kif.re.kr)
In 2011, the KRW/USD exchange rate is expected to
average KRW1,111 from KRW1,156 in 2010.
Throughout the remaining period of 2011, the
KRW/USD is expected to hover at a somewhat elevated
level with high volatility. This is because of strong risk
aversion, which has led to large sell-offs of emerging
market assets in the international financial markets,
does not look like it will disappear easily until the euro-
zone finalizes plans to address the fiscal crisis.
Stock Prices
Hyungjoon (Ray) Lim (hjlim@kif.re.kr)
In Q4 2011, the downside risks for Korean equities
include a global economic recession and the fallout
from the debt crisis in the euro zone. Furthermore, risk
appetite would likely decrease from the increasing
financial market volatility and worries about further
Korean Economic and Financial Review [October 2011]30
sell-off by foreign investors.
The upside risks, however, are expected to balance out
the downside risks. The euro zone is pushing ahead
with increasing the scale of the European Financial Sta-
bility Facility (EFSF) which could support Greece and
other ailing countries. And various asset prices might
increase owing to central banks’ quantitative easing
such as ‘Operation twist.’ As a result, the KOSPI in Q4
is expected to hold steady around its present level.
B. Money and Credit
Kyoobok Lee (leekb@kif.re.kr)
In July and August, the low rate of growth in the money
supply continued mainly as a result of the tight-money
policy. While the average growth rate of M2, or broad
money in July and August, increased to 3.6% y.o.y.,
0.1%p higher than the second quarter, those of reserve
base and M1 fell to 11.5%, 4.6% respectively.
Monetary Aggregates
The average reserve base increased by 11.5% y.o.y.
between July and August, lower than the 11.8% in Q2.
This was mainly because growth in new bank notes &
coins fell to 15.3% during the two month period, lower
than the 17.5% Q2. Also, BOK’s liabilities to deposi-
tory institutions increased 8.1% in July and August
2011, 1.2%p higher than in Q2 2011.
The amount of outstanding Monetary Stabilization
Bonds (MSBs), used to measure and monitor market
liquidity, increased slightly to KRW169.9 trillion won
at the end of August 2011, up KRW2.9 trillion from the
end of June 2011. But monthly average issuance in
MSBs decreased to KRW1.7 trillion between July and
August from KRW2.0 trillion in Q2 2011.
In the July and August, the M2 growth, which was
Financial Markets and Industries 31
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.
3.5% in Q2, was 3.6% as the flow of funds from over-
seas fell. With continued deficits in the capital account,
the current account during July and August of 2011
decreased by USD2.259 billion compared to the same
period in 2010. From July to August, the average out-
standing CD decreased by 43.8%, or KRW24.0 trillion
y.o.y., after falling by 53.3% in Q2 2011. Also, that of
MMF decreased by 31.2% during the same period.
Meanwhile, beneficial certificates increased by 2.3%
compared to △5.1% in Q2.
Savings deposits’ average outstanding (under 2-yr
maturity) increased by 11.0%, or KRW82.5 trillion
y.o.y. leading M2 growth in July and August.
On the other hand, in only August, M2 increased by
4.0% mainly because of bank lending growth rose.
The averaged growth of Lf (liquidity aggregates of
financial institutions, previously M3) increased to 5.1%
in July and August, from 4.3% in Q2 2011.
Business and Household Credit
Total depository banks’ corporate lending at the end of
September 2011 was KRW553.6 trillion, which was
made up of KRW444.9 trillion in small- and medium-
sized enterprise (SME) loans and KRW108.7 trillion in
large enterprise (LE) loans.
Total depository banks’ corporate lending increased
KRW13.8 trillion in Q3. Lending to LEs increased by
KRW9.2 trillion as banks met greater demand for
working capital and lower lending rates with efforts to
expand their lending to LEs. Lending to SMEs also
increased by KRW4.6 trillion from KRW2.9 trillion in
Q2. On the other hand, in August, lending to SMEs
increased by only KRW0.1 trillion as loans were repaid
at the start of August.
In Q3, household lending increased by KRW5.5 tril-
lion, lower than the KRW4.3 trillion won increase in
Q2 as the banks reined in lending in accordance with
the government policy to the effect.
Korean Economic and Financial Review [October 2011]32
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.
2011
1Q 2Q 3Q Jul. Aug. Sep.
Corporate 12.6 10.1 13.8 5.9 3.1 4.8Loans
(LEs) 5.0 7.2 9.2 3.2 3.0 3.1
(SMEs) 7.7 2.9 4.6 2.8 0.1 1.7
Household 3.0 9.1 5.5 2.3 2.5 0.6Loans
(Mortgage1)) 4.7 6.1 4.3 1.9 1.2 1.1
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. Source: BOK.
2011
1Q 2Q 3Q Jul. Aug. Sep.
Stock3.3 3.4 0.6 0.4 0.1 0.1
issuance2)
Net issuance1.2 △2.2 6.3 3.6 1.4 1.3
of CP3)
Net issuance of4.1 5.1 4.8 1.0 1.8 1.9
corporate bonds
Total 8.5 6.3 11.6 5.0 3.3 3.3
Corporate direct financing increased by KRW11.6 tril-
lion in Q3 2011, compared to KRW6.3 trillion in Q2.
More specifically, corporate bond issuance through
public offerings increased by KRW4.8 trillion in Q3,
less than that in Q2, but still large. Net CP issuance
increased by KRW6.3 trillion mainly due to demand for
working capital.
Meanwhile, financing through the stock the market
increasing by only KRW0.6 trillion in Q3 as the KOSPI
declined.
Beneficiary certificates at investment trust manage-
ment companies (ITMCs) increased except for bond-
types during Q3 2011. Deposits in equity-type invest-
ment funds increased by KRW2.4 trillion during the
quarter. Also new-type and bond-equity-type deposits
increased by KRW3.7 trillion won and KRW0.6 trillion
respectively during the quarter. But bond-type invest-
ments decreased by KRW1.1 trillion.
Outlook for 2011
In Q4 2011, corporate bank lending and household
bank lending will not rise much because of increasing
global uncertainties and strengthening of government
regulations. Banks are there fore expected to focus on
improving their risk management instead of increasing
asset growth.
Financial Markets and Industries 33
Figure ⅡⅡ.9 Beneficiary Certificates at ITMCs
Source: BOK.
C. Financial Industries
1. Banking Industry
Hyoungsik Noh (hsnoh@kif.re.kr)
Asset Growth
The Korean banks’ assets decreased slightly to
KRW1,913 trillion during Q2 2011, down 0.4% from
the previous quarter. Yet, this is up 1.8% from a year
ago. While banking accounts stayed nearly flat, trust
accounts decreased by 3.6% over the previous quarter.
In banking accounts, cash and due from banks and
securities decreased by KRW3.5 trillion and KRW9.0
trillion whereas loans and discounts increased by
KRW13.9 trillion. Trust accounts that had showed a
steady growth since Q1 2009 decreased as a result of
decreases in repos, loans and discounts, and bond
accounts.
Total loans by Korean banks were KRW982.5 trillion, a
1.9% increase from the previous quarter, the highest
quarterly growth since Q3 2008. This pick up was
mainly driven by an increase in household loans by
KRW9.1 trillion. Mortgage loans showed a steady
increase, up 1.9% from the previous quarter thanks to
ongoing low level of interest rates and banks’ efforts to
expand their mortgage lending. Other loans, including
via overdraft accounts, also rose to KRW147.8 trillion
reflecting seasonal factors. Corporate loans increased
1.8% from the previous quarter driven by bank loans to
large enterprises, which hit KRW99.6 trillion, up by
7.9% from the previous quarter. SME loans showed a
slow increase of KRW2.4 trillion, up by 0.5%. This was
primarily the result of domestic banks’ efforts to
increase lending to large enterprises and high demand
of short-term working capital. Slow growth in SME
loans is attributable to banks’ writing off bad debts and
repayments of loans out for SMEs’ settlement funds.
Korean Economic and Financial Review [October 2011]34
Figure ⅡⅡ.10 Assets of Korean Banks1)
Note: 1) End of period.
Source: FSS.
(Unit: tril. won)
Profitability
In Q2 2011, Korean banks achieved KRW5.9 trillion in
net income based on K-IFRS, up markedly by 31.3%
from the previous quarter. This huge jump is more vivid
when compared to the figure a year ago of KRW1.3 tril-
lion. The strong growth was driven by a hike in non-
interest income. Especially, a one-off gain of KRW3.2
trillion from the sale of shares in Hyundai Engineering
and Construction was the primary factor of the increase
in profitability. Out of net income, KRW0.5 trillion will
be reserved for loan loss aiming at mitigating the
decline in loan loss provisions under K-IFRS. Consid-
ering loan loss reserve, which make up for additional
loan loss provisions under K-IFRS, it is not easy to see
that there was a significant improvement in profitabil-
ity of domestic banks.
Despite a slight decline in NIM, interest income man-
aged to grow by KRW0.1 trillion hitting KRW9.8 tril-
lion as a result of a big increase in interest bearing
assets. However, interest income’s share in total
income (the sum of non-interest income and interest
income) decreased to 67.6%, down from 81.5% in the
previous quarter.
Non-interest income increased significantly to
KRW4.7 trillion, up 147.4% from a year earlier or up
113.6% over the previous quarter.
Korean banks’ loan loss provisions increased to
KRW2.6 trillion, up by KRW0.2 trillion from the previ-
ous quarter or down by KRW3.4 trillion over a year
ago.
Soundness and Capital Adequacy
The asset soundness of Korean banks greatly improved
as the NPL ratio eased to 1.73%, down by 0.27%p over
the previous quarter, thanks to aggressive leveling
down of bad debts. This is the record low since real
estate PF loans had emerged as a serious problem in Q2
2010. While new bad debts increased to KRW6.2 tril-
lion, cleaning up of bad debts through write-offs and
Financial Markets and Industries 35
Table ⅡⅡ.6 Composition of Banks’ Net Income(Unit: tril. won)
Note: Net income is cumulative.Source: FSS.
10.4/4 11.1/4 11.2/4
Net Interest Income 9.5 9.7 9.8
Net Non-Interest Income 1.4 2.2 4.7
Table ⅡⅡ.5 Composition of Bank Loans(Unit: tril. won)
Note: Includes Korea Development Bank.Source: BOK.
10.2/4 10.3/4 10.4/4 11.1/4 11.2/4
LE 83.1 87.3 87.3 92.3 99.6
SME 434.9 436.6 429.7 437.4 439.8
Housing 273.2 276.8 284.6 289.9 295.4
Others 143.7 143.8 145.8 144.2 147.8
Figure ⅡⅡ.11 Net Interest Margin
Source: FSS.
(Unit: %)
sales of NPL to PF Normalization Bank led to a
decrease in NPL by KRW3.2 trillion over the previous
quarter.
Korean banks’ ability to absorb loan losses expressed
in NPL coverage ratio recovered to 118.0% from the
figure of 107.6% in the previous quarter.
The BIS capital adequacy ratio of Korean banks in Q2
2011 was 14.40%, up 0.08%p over the previous quarter
or up 0.11%p from a year earlier. The Tier 1 ratio
climbed to 12.08%, up 0.82%p over the previous quar-
ter or up 0.75%p from a year earlier, which is more pro-
nounced that the BIS ratio. While Tier 1 capital
increased by KRW4.3 trillion, non-qualified supple-
mentary capital among subordinated debts increased by
KRW2.6 trillion resulting in a mere increase of
KRW1.3 trillion in BIS capital. The quality of capital
improved due to the relatively fast growth in Tier 1 cap-
ital.
Outlook
Growth opportunities for Korean banks are expected to
lie in cash and due from banks and loans in Q4 2011. It
seems that an inflow of savings deposits from mutual
saving banks will continue for a while because of the
possibility of additional restructuring as well as an air
of anxiety about troubled mutual saving banks.
In Q4 2011, corporate loans are expected to grow
slightly owing to bank’s efforts to expand loans and
demand of working capital. Household loans are
expected to slow down due to the enhancement of the
regulation to household debt level.
Interest income is expected to show a slight recovery
due to a rise in NIM. Non-interest income is expected to
scale down because of little chance of capital gains
from equity sales and good chance of devaluation in
securities under the current global financial woes.
Funding costs have a room for improvement through
the inflow of market funds.
Korean Economic and Financial Review [October 2011]36
Figure ⅡⅡ.13 Growth Rate of Demand Depositand CMA
Source: FSS.
Figure ⅡⅡ.12 BIS Ratio and Sub-StandardLoan Ratio
Source: FSS.
(Unit: %)
(Unit: %)
Despite the worries about growth of new NPLs, it is
expected that Korean banks will manage to maintain
asset soundness in Q4 2011 through the preemptive
recognition of latent distress in the weakest areas and
efforts of leveling down of bad debts. It is still neces-
sary to be proactive in managing soundness of SME
loans under the slow pace of economic growth and
sedate real estate markets.
The capital adequacy of Korean banks is expected to
deteriorate slightly. Relatively faster growth in risk-
weighted assets than Tier 1 capital is expected to put
capital adequacy ratio under pressure. This pressure
can be mitigated by a reduction of bad debts.
Financial Markets and Industries 37
2. Non-Banking FinancialInstitutions
Soonho Lee (soonholee@kif.re.kr)
Credit Card Companies
During the second quarter of 2011, the total assets of
credit card companies increased 3.8% to 76.4 trillion
won, up from 73.6 trillion won in the previous quarter
(Figure Ⅱ.14). Card assets, which comprise the largest
portion of total assets, increased by 1.1% to 57.6 trillion
won q.o.q. from receivables on credit card lump sum
sales and receivables on credit card installment sales.
The outstanding balance of loan & factoring increased
from 2.9 trillion to 4.1 trillion won. Because of the
decrease in operating lease assets and increased install-
ment financing assets for machinery, lease & install-
ment assets stayed flat at 2.8 trillion won. An increase
in cash and cash equivalents led to an increase of cur-
rent & fixed assets of 7.5% to 8.6 trillion from 8.0 tril-
lion won.
Total net income in Q2 2011 soared 3.5% to 534.6 bil-
lion from 516.3 billion won q.o.q. (Figure Ⅱ.15).
Because loan loss provisions regulations were strength-
ened, total net income decreased compared to those of
Q4 2010. Shinhan Card recorded net profits of 192.7
billion won as the most profitable credit card company,
which was down 22.7% from 249.3 billion won q.o.q.
Samsung Card registered profits of 111.0 billion won,
which was up from 101.9 billion won q.o.q. The net
income of Kookmin Card, recent spun off from the
bank, realized 68.2 billion won.
There was a decrease in the adjusted average capital
ratio, which decreased from the previous quarter's
26.7% to 26.6% (Table Ⅱ.7). This decrease was due to
the increase of adjusted total asset caused by competi-
tive sales expansion. Thanks to the continuing increase
in debt repayment ability of the households, the com-
bined delinquency ratio of credit card companies
decreased during 29 months. But in Q2 2011, delin-
quency ratio slightly worsened. Meanwhile, the sub-
Korean Economic and Financial Review [October 2011]38
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.
2010 2011
2Q 3Q 4Q 1Q 2Q
Adjusted30.2 29.7 28.5 26.7 26.6capital ratio
Delinquency1.8 1.8 1.7 1.6 1.7ratio
Substandard &below loans 1.5 1.4 1.3 1.2 1.1
ratio
ROA 3.8 3.8 5.5 3.8 3.4
ROE 13.6 13.4 19.8 15.8 14.2
(Unit: bil. won)
(Unit: tril. won)
standard & below loan (SBL) ratio stood at 1.1%,
0.1%p lower than in the previous quarter. ROA and
ROE declined 0.4%p and 1.6%p, respectively.
Credit card companies need to keep their existing cus-
tomers due to the competition with the recently spun off
credit card companies from banks. As financial author-
ity has strenthened the regulations on financial indica-
tors such as aseet growth rate and total marketing costs,
their asset growth is expected to shrink.
Credit Finance Companies Other than Credit Card Companies
During Q2 2011, total assets of credit finance compa-
nies increased 1.0% to 72.7 trillion from 72.0 trillion
won in the preceding quarter (Table Ⅱ.8). Total assets
maintained growth since Q3 2009. The total assets of
leasing companies and installment financing compa-
nies grew 2.7% to 26.3 trillion won and 1.5% to 41.6
trillion won, respectively. The total assets of venture
capital companies decreased by 9.3% to 4.9 trillion
won due to a decrease of corporate investments. Total
durables installment assets in credit finance companies
increased by 1.3% to 11.6 trillion won (Figure Ⅱ.16).
As there was an increase in new car purchases,
increased new auto capital was the main factor of the
durables installment assets growth. Because of a
decrease in the sales growth of foreign cars, the operat-
ing lease assets reduced to 7.0 trillion won (Figure
Ⅱ.16). As housing trades increased from 320 thousand
houses to 330 thousand houses, the house installment
assets increased 16.0% to 1.1 trillion won.
The net income of credit finance companies was 418.5
billion won, an increase of 8.2% q.o.q. from 386.9 bil-
lion won (Table Ⅱ.9). The total net income of install-
ment companies went up 279.9 billion won from 233.9
billion won, while the net income of leasing companies
decrease to 111.9 billion won from 137.3 billion won.
Owing to a net income surplus, the ROA of most credit
finance companies increased. Meanwhile, the SBL
ratio of credit financing companies declined. Espe-
Financial Markets and Industries 39
Table ⅡⅡ.8 Total Assets at Credit FinanceCompanies (Excluding Credit Card Companies)
(Unit: tril. won)
Source: FSS.
2010 2011
2Q 3Q 4Q 1Q 2Q
Leasing 23.4 24.4 25.2 25.6 26.3companies
Installmentfinance 33.6 34.5 36.3 41.0 41.6
companies
Venturecapital 4.3 4.5 4.8 5.4 4.9
companies
Total 61.3 63.4 66.3 72.0 72.7
Figure ⅡⅡ.16 Assets at Credit FinanceCompanies (Excluding CreditCard Companies)
Source: FSS.
(Unit: bil. won)
Table ⅡⅡ.9 Financial Indicators of CreditFinance Companies (Except Credit Card Companies)
(Unit: bil. won, %)
Note: Net income is calculated quarterly.Source: FSS.
2010 2011
3Q 4Q 1Q 2Q
Lease △1.1 75.4 137.3 111.9
Installment 196.7 62.7 233.9 279.9
Venture capital 25.0 30.2 15.7 26.7
Total 220.6 168.3 386.9 418.5
Lease 0.7 0.8 0.9 1.3
Installment 2.1 1.9 1.2 1.4
Venture capital 1.8 2.1 1.8 1.6
Lease 74.7 77.5 88.7 96.1
Installment 99.9 93.6 104.2 102.9
Venture capital 52.9 70.2 88.6 88.4
Lease 5.7 4.1 4.1 3.7
Installment 2.9 3.4 2.9 2.8
Venture capital 5.1 4.4 4.9 3.7
Lease 16.7 16.2 16.2 16.3
Installment 16.3 15.0 13.3 13.8
Venture capital 35.0 34.8 30.8 29.7
ROA
Loan lossreserve
ratio
Sub standard & below
loans ratio
Adjustedcapitalratio
Netincome
cially, since the ratio of the venture capital companies
indicated 4.0% in Q4 2008, the ratio recorded the low-
est at 3.7%. Meanwhile, except for the venture capital
companies, the capital adequacy ratio of credit finance
companies slightly improved.
The increase in the competitive pressure by credit cards
purchase of car and durable goods is increasing operat-
ing costs. Due to European recession, the growth of the
Venture capital companies is expected to atrophy.
Mutual Savings Banks (MSBs)
In the second half of FY2010 (2011.1.1~6.30),
decreased loans led the decline in total assets although
call loans and cash increased significantly. Mutual sav-
ings bank (MSB) failures were also a large factor of
decreasing total assets of MSB. Total MSB assets fell
11.5% to stand at 76.9 trillion won. As MSB business
suspensions were imposed, deposit account holders
withdrew funds, bringing deposits down by 7.4% to
71.1 trillion won. Loans decreased by 9.9% to 58.3 tril-
lion won for this period (Figure Ⅱ.17). Because of the
discontinued new project financing loans and quickly
increased loan loss provisions were main factor of
decrease of loans assets.
During the second half of FY2010, the net income of
MSBs recorded a deficit of 53,157 billion, which was
due to the net operating income deficit of the suspended
savings banks. Especially 68 MSBs out of 104 MSBs
recorded deficits. As the net income of MSBs indicated
a deficit, ROA was △6.7%. Since indicating at △31.97%
during the second half of FY2001, it showed the worst
figures. In addition, the SBL ratio, which shows the
asset soundness of MSBs, worsened from 10.8% to
26.6% over H2 FY2010. This deterioration was due to
increased SBL PF loans. Meanwhile, the BIS capital
adequacy ratio of MSBs indicated 1.1%. 22 savings
banks were recorded minus BIS capital ratio.
In H1 FY2011, due to strengthened regulatory stan-
dards on loan soundness by Financial Supervisory Ser-
vice (FSS), MSBs will be expected to increase the pro-
portion of safer-asset investment rather than realestate-
Korean Economic and Financial Review [October 2011]40
Table ⅡⅡ.10 Financial Indicators of MSBs (Unit: bil. won, %)
Note: Net income is calculated biannually. Source: FSS.
2009.6 2009.12 2010.6 2010.12 2011.6
Net Income △2,061 1,343 △10,263 △6,010 △53,157
ROA △0.1 0.2 △0.9 △0.7 △6.7
BIS Capital Ratio
9.4 9.3 9.0 9.0 1.1
Substandard& Below 10.3 9.3 10.6 10.8 26.6
Loans Ratio
Figure ⅡⅡ.17 Total Assets, Deposits & Loansat MSBs
Source: FSS.
related loans. To strengthen their competitiveness,
MSBs will need to enhance their profitability. Because
the restructuring of the MSB industry is now in
progress, MSBs will have to raise capital by issuing
stocks to expand capital adequacy. In spite of high
interest rates, deposits of MSBs will continue to
decrease because of reduced reliability.
Mutual Credits (MCs)
This category includes agricultural cooperatives (ACs),
fisheries cooperatives (FICs), forestry cooperatives
(FOCs) and credit unions (CUs). During Q2 2011, the
total assets of mutual credit institutions (MCs)
increased slightly by 1.3% q.o.q. to stand at 314.9 tril-
lion won (Table Ⅱ.11). Total deposits rose by 1.1% to
258.7 trillion won from 256.0 trillion won. Because of
the increased tax-free savings limits and balloon effect
of mutual savings banks failures, the upward trend in
deposits continued over time. Total credits rose about
3.7% from 186.2 trillion won to 189.9 trillion won.
Since Q4 2010, loans increased more rapidly than
deposits, so the ratio of credits to deposits increased
over Q2 2011.
Because of increased operating revenues from loans to
retail borrowers, mutual credit institutions registered
positive net income (Table Ⅱ.12). The total combined
net income of MCs was 827.7 billion won in Q2 2011.
In the previous quarter, FOC income indicated a deficit
of 18.0 billion won. But this quarter, the income
inverted to positive direction. Furthermore, CUs, ACs
and FICs registered a net income of 145.5 billion won,
613.0 billion won and 36.4 billion won, respectively.
Except for ACs, MCs ROA was improved. The ratio of
ACs declined slightly to 0.2%p, while the ROA of
FOCs increased to 0.7% from △1.6%. Loan soundness
improved partially. With the exception of ACs which
stood at the same level, delinquency ratio of most MCs
improved. Especially, FICs rearranged insolvent oblig-
ations in Q2 2011. Also, the SBL ratio of ACs and FICs
fell by 0.1%p to 1.9%, and by 0.2%p to 3.5%. Most of
the MCs loan-loss reserve ratio increased. However
FICs loan-loss reserve ratio deteriorated slightly. MCs
Financial Markets and Industries 41
Table ⅡⅡ.11 Total Assets & Ratio of Credits toDeposits at Mutual Credits
(Unit: tril. won, %)
Source: FSS.
2010 2011
2Q 3Q 4Q 1Q 2Q
Total Assets 294.5 300.1 310.5 310.8 314.9
Credits 178.0 181.3 184.9 186.2 189.9
Deposits 242.2 246.6 254.3 256.0 258.7Ratio of Credits
73.5 73.5 72.7 72.8 73.4to 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 2011
3Q 4Q 1Q 2Q
Credit Unions 112.3 37.7 116.3 145.5
Agricultural 437.4 △241.3 820.2 613.0
Fisheries 15.8 39.6 11.8 36.4
Forestry 9.3 12.4 △18.0 32.7
Total 574.8 △151.6 930.2 827.7
Credit Unions 0.9 0.8 1.0 1.1
Agricultural 1.0 0.6 1.4 1.2
Fisheries 0.6 0.7 0.3 0.6
Forestry 1.1 1.1 △1.6 0.7
Credit Unions 7.3 6.5 7.0 6.8
Agricultural 3.8 3.1 3.6 3.6
Fisheries 6.7 5.6 5.8 5.4
Forestry 7.7 6.3 7.4 7.0
Credit Unions 4.0 3.7 3.7 3.7
Agricultural 2.0 2.0 2.0 1.9
Fisheries 3.7 3.3 3.7 3.5
Forestry 3.5 3.2 3.7 3.7
Credit Unions 103.8 106.2 106.3 106.4
Agricultural 163.0 180.9 172.5 173.3
Fisheries 122.1 129.6 130.7 125.9
Forestry 110.8 112.7 112.8 114.9
Credit Unions 3.5 3.4 3.4 3.7
Agricultural 7.9 8.0 8.1 8.3
Fisheries 2.2 2.4 2.1 2.6
Forestry 11.3 11.3 10.8 11.4
Delinquencyratio
Substandard &belowloansratio
Loan-lossreserve
ratio
Net capitalratio
Netincome
ROA
faced developed capital adequacy compared with the
previous quarter.
Due to the balloon effect of savings banks restructuring,
new deposit accounts will increase consistently. So MCs
asset growth and profitability will improve. However, in
case of a rise in the base rate of interest, there is the
potential of insolvent risk from existing household loans.
3. Securities Industry
Junghan Koo (jhkoo@kif.re.kr)
Assets
Securities firms’ assets increased by 23.1% to
KRW248 trillion during Q2, up from KRW201.6 tril-
lion a year earlier (Figure Ⅱ.18). This was mainly
attributable to the increase in receivables by KRW27.1
trillion won.
The ratio of securities firms’ asset size to commercial
banks’ asset size increased by 3.8%p, up from 17.1%
during the same quarter last year. While commercial
banks’ asset size increased by 0.7%p, securities firms'
asset size increased significantly over the same period.
This is because the asset size of commercial banks has
remained stable after the global financial crisis. The
HHI (market concentration index) of securities firms
was only 392, significantly lower than that of commer-
cial banks at 1,479. This indicates that market share is
not concentrated in a few securities companies.
Profitability
In Q2 2011, securities firms’ profits increased by
65.9% over the same period last year to KRW992 bil-
lion (Figure Ⅱ.19). Brokerage commissions increased
due to the increased trading volume while fees from
asset management services increased significantly due
to the increased investments in wrap accounts. Gains
from securities holdings also increased as stock prices
rose from the market rally.
Korean Economic and Financial Review [October 2011]42
Figure ⅡⅡ.19 Profits of Securities Companies
Source: FSS.
Figure ⅡⅡ.18 Total Assets of SecuritiesCompanies
Source: FSS.
(Unit: bil. won)
(Unit: tril. won)
Capital Adequacy
The net capital ratio (net capital over total risk, an indi-
cator of the capital adequacy of securities companies)
fell 42%p from 556% at the end of Q1 2011 to 514% at
the end of Q2 2011 (Figure Ⅱ.20). Total risk increased
by 3.4% from the last quarter, while net operating capi-
tal decreased by 4.2% over the same period.
As securities firms expanded their bond holdings, risks
related to interest rates increased. There have been ups
and downs in the ratio over last a few years. However, it
does not indicate that securities firms increased their
investment banking businesses actively. They are
exposed mainly to market risks from holding securities.
As market indicators, such as stock price and interest
rates, move their total risk have ups and downs.
Although the ratio decreased in Q2 2011, it is still well
above the FSC’s recommended level of 150%.
Outlook
In Q4 2011, the assets of securities firms are expected
to decrease. The debt crisis in the euro zone will inten-
sify uncertainty on the financial markets. In addition,
uncertainty over a possible rebound in the U.S. econ-
omy still lingers. Investors are likely to prefer safe
assets until the uncertainties become more manageable.
Profitability is expected to decrease as fees related to
asset management services will be pushed down to
relieve investors’ costs. If the external factors, such as
the debt crisis in eurozone and uncertainty over the eco-
nomic rebound in the U.S., worsen brokerage commis-
sions will also decrease. Unless they can develop new
financial instruments with stable returns, profits will
deteriorate.
Capital adequacy is expected to deteriorate due to
volatile financial markets. However, it will remain
within a sound level. Since the net capital ratio is still
over 500%, securities firms have cushion to absorb the
negative impact from the world financial markets.
Financial Markets and Industries 43
Table ⅡⅡ.13 Total Value of Stock Trading &Commission Income
(Unit: tril. won)
Source: FSS, KRX.
10.2Q(4~6) 11.2Q(4~6)
Total Value of Trading 350 477
Commission Income 1.91 2.15
Figure ⅡⅡ.20 Net Capital Ratio of SecuritiesCompanies
Source: FSS.
(Unit: %)
4. Insurance Industry
Sukho Lee (slee@kif.re.kr)
Life Insurance
At the end of Q1 FY2011, the total assets of life insur-
ance industry amounted KRW425 trillion, a 2.0%
increase over the previous quarter mainly due to contin-
ued increase in the inflow of premium income and
increase in appraised value of securities invested. Pre-
mium income was KRW19.5 trillion, up 1.4% y.o.y.
This upward trend of both total assets and premium
income seems to have persisted into Q2 FY2011 as
well. Meanwhile, total claims paid by life insurers
increased 12.3% y.o.y. to KRW12.7 billion (Table
Ⅱ.14).
The respective percentages of premium income from
death insurance, pure endowment insurance, endow-
ment insurance, and group insurance were 50.4%,
28.9%, 19.3%, and 1.4% (Figure Ⅱ.21). The share of
endowment insurance increased 1.8%p while pure
endowment insurance, death insurance, group insur-
ance decreased 0.3%p, 1.5%p, and 0.1%p respectively
y.o.y. The share of premium income from endowment
insurance continued to trend higher, thanks to its rela-
tive competitiveness to other savings type financial
products under a low interest rate trend environment
and the continued slowdown in the real estate market.
The proportion of premium income of pure endowment
insurance decreased although its premium income rose
by 1.5%p thanks to steady demand for after-retirement
products. The share of death insurance fell slightly in
spite of an increase in demand for whole life insurance.
Meanwhile, the proportion of group insurance contin-
ued to trend lower.
As of Q1 FY2011, the market share of top three life
insurers, small & medium-sized life insurers, and for-
eign life insurers were 50.4%, 27.7%, and 21.9%
respectively. The market share of the top three life
insurers declined again, by 1.9%p, mainly due to some-
what poor performance in sales of death insurance. The
Korean Economic and Financial Review [October 2011]44
TableⅡⅡ.14 Life Insurance Industry Indicators1)
(Units: bil. won, %)
FY2009 FY2010 FY2011
4Q 2Q 4Q 1Q
Total 372,525 397,611 416,652 425,045Assets2) (3.1) (4.2) (2.0) (2.0)
New 92,127 86,014 96,580 87,065Contracts (△12.9) (△14.9) (4.8) (10.6)
Policies in 1,731,603 1,747,068 1,793,211 1,816,788Force2) (0.3) (0.8) (1.5) (1.3)
Premium 19,142 19,237 21,210 19,502Income (8.6) (7.2) (10.8) (1.4)
Claims12,587 11,201 14,722 12,702(1.3) (4.2) (17.0) (12.3)
Expenses1,394 1,319 1,576 1,348(16.2) (8.0) (13.1) (△6.0)
17.3 16.3 16.0 15.7
50.9 52.1 52.8 53.0
2.6 2.8 2.8 3.3
3.2 3.0 2.9 3.0
26.1 25.7 25.5 25.1
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
Figure ⅡⅡ.21 Premium Breakdown of the LifeInsurance Industry
Note: End of June 2011.
Sources: FSS, KLIA, KIF.
(Unit: %)
market share of small & medium-sized life insurers
increased by 2.1%p y.o.y.
While the market share of foreign life insurers recently
has been stagnating somewhat, it has been known that
some of foreign life insurers are looking to expand.
At the end of Q1 FY2011 the total operating profits of
the life insurance industry was KRW7.7 trillion, up
5.3% over the same period last year. Underwriting prof-
its increased 9.8% y.o.y. to KRW3.5 trillion, while
investment profits showed a 1.8% rise to KRw4.2 tril-
lion. The growth in underwriting profits occurred
mainly due to an increase of 0.5% in operating revenue
and a fall of 2.3% in operating cost y.o.y. On the invest-
ment side, while operating revenue increased 2.7%p
y.o.y thanks to the increase in interest income and prof-
its on disposals of marketable securities, operating cost
showed stronger growth (6.7%p). Meanwhile, at the
end of Q1 FY2011, the net profits of life insurance
industry reached KRW1.09 trillion.
Non-Life Insurance
As of the end of June 2011, total assets of the non-life
insurance industry was KRW112.9 trillion, a 10.4%
increase over the end of the previous quarter. This was
mainly driven by the continued increase in an inflow of
written premiums, investment returns on assets, and
improvement in loss ration of automobile insurance.
Written premiums during Q1 FY2011 were up 14.0%
y.o.y. to KRW13.4 trillion, which is attributed to con-
tinued growth in sales of long-term non-life insurance
and individual pension insurance. Total claims paid by
non-life insurers increased 21.0% y.o.y. to KRW5.1
trillion while total management expenses decreased
3.0% y.o.y. to KRW2.4 trillion (Table Ⅱ.15).
As shown in Figure Ⅱ.24, the market share of long-
term non-life insurance, automobile insurance, special
type insurance, individual pension insurance, guarantee
insurance, marine insurance, and special type insur-
ance, personal pension insurance, guarantee insurance,
marine insurance, and fire insurance accounted for,
Financial Markets and Industries 45
Figure ⅡⅡ.22 Market Share of Life InsuranceIndustry
Note: End of June 2011.Sources: FSS, KLIA, KIF.
(Unit: %)
Figure ⅡⅡ.23 Business Performance of LifeInsurance Industry
Note: End of June 2011.
Sources: FSS, KLIA, KIF.
(Unit: Billion KRW)
respectively, were 57.3%, 23.9%, 8.2%, 5.7%, 2.6%,
1.8%, and 0.6% of total premiums. Compared to the
same period last year, the share of long-term non-life
insurance and personal pension insurance increased
0.6%p and 1.0%p while the share of automobile insur-
ance, special type insurance, guarantee insurance, and
fire insurance decreased 1.1%p, 0.3%p, 0.1%p, and
0.1%p respectively y.o.y. The share of automobile
insurance decreased although its written premiums
grew from stronger growth in the sales of long-tern
non-life insurance. The proportion of long-term non-
life insurance continued trending higher thanks to con-
tinued growth in sales of savings-type insurances and
steady demand for property, casualty, and illness insur-
ance.
As of the end of June 2011, the top five non-life insur-
ers still dominated the non-life insurance market
(77.7%), rising 1.4%p y.o.y., which is mainly driven by
continued growth of both long-term non-life insurance
and individual pension insurance. The market share of
SME non-life insurers dropped by 1.1%p y.o.y to
19.5% while those of foreign non-life insurers and went
up 0.3%p y.o.y to 2.8%. In particular, the growth rate of
written premiums for SME non-life insurers (8.1%)
were weaker those of top five non-life insurers (16.1%)
during the period y.o.y.
At the end of June 2011, non-life insurers’ total operat-
ing profits recorded KRW0.96 trillion, a 42.4%
increase over the same period last year. Investment
profits were KRW0.91 trillion, a 16.3% increase over
the same period last year thanks to the increase in prof-
its on the disposal of marketable securities. In under-
writing, the continued deficit trend has been shifted to a
surplus of KRW0.04 trillion won during the period,
which is mainly attributed to continued growth in sales
of long-term non-life insurance and improvement in the
loss ratio in automobile insurance.
Outlook
Total assets and premium income of the life insurance
companies in Q2 FY2011 maintained its growth trend
Korean Economic and Financial Review [October 2011]46
TableⅡⅡ.15 Key Indicators for the Non-lifeInsurance Industry
(Units: bil. won, %)
FY2009 FY2010 FY2011
4Q 2Q 4Q 1Q
Total 86,163 94,449 102,267 112,888Assets (3.8) (4.6) (3.3) (10.4)
Direct Premiums
11,962 12,101 12,756 13,399
Written (29.1) (16.3) (6.6) (14.0)
Direct 5,460 5,211 5,590 5,088Claims Paid (22.3) (9.6) (2.4) (21.0)
Management 2,648 2,602 2,782 2,363Expenses (2.5) (3.5) (5.1) (△3.0)
50.9 51.9 51.5 48.3
17.8 17.3 17.8 16.9
4.9 5.3 5.2 5.6
5.9 5.7 5.5 5.4
20.5 19.9 20.0 23.8
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.
Notes: 2) Mostly accounts receivable.Source: FSS, Korea Non-Life Insurance Association
(KNIA), KIF.
Securities Loans Cash &
DepositsReal Estate
Other2)
Figure ⅡⅡ.24 Premium Breakdown of Non-LifeInsurance Industry
Note: End of June 2011.Source: FSS, KNIA, KIF.
(Unit: %)
through further growth in the retirement pension mar-
ket, continued improvement in performance of savings-
type products, among others. While this is expected to
continue during Q3 FY2011, the growth rate could
weaken due to the prevailing uncertainties in global and
domestic financial markets. Meanwhile, savings type
insurance products, which are mainly driven by
increased demand for pension products under a rapidly
aging society, are expected to continue its upturn trend.
The upturn trend of savings-type insurance products
should grow stronger through the called “safety asset
preference” trend with financial markets growing more
uncertain. The retirement pension market is expected to
expand further thanks to various institutional support-
ing programs and steadily increasing demand for after-
retirement products. Meanwhile, life insurers’ rate of
return on investments are expected to fall as the ongo-
ing low interest rate policy is forecast to continue and
financial markets are getting more vulnerable and fluc-
tuated. In particular, life insurers are more vulnerable in
a low interest trend since more than 60% of invested
assets of life insurance company is configured as inter-
est based assets.
In Q3 FY2011, total assets and premium income of
non-life insurance companies are expected to continue
trending higher. However, due to the uncertainties in
the financial markets and the possibility of an economic
slowdown, the growth rate is expected to weaken
somewhat for non-life insurers as well. For the long-
term non-life insurance and savings type products are
expected to maintain the upturn trend, while protection
type products are expected to show somewhat better
performance. Meanwhile, under the recently continued
inflation trend, there are concerns that the loss ratio of
automobile insurance and medical expense insurance
are rising due to an increase in labor costs and medical
expenses, among others. On the investment business
side non-life insurers, like life insurers, have to pay
attention to the possibility of a fall in the rate of return
on investment and investment income as the global
financial crisis deepens.
Financial Markets and Industries 47
Figure ⅡⅡ.26 Business Performance of Non-Life Insurance Industry
Note: End of June 2011.Source: FSS, KNIA, KIF.
(Unit: Billion KRW)
Figure ⅡⅡ.25 Market Share of Non-LifeInsurance Industry
Note: End of June 2011.Source: FSS, KNIA, KIF.
(Unit: %)
Korean Economic and Financial Review [October 2011]48
A. Analysis of the Determinantof Non-banking FinancialCompanies' Interest Rates
Kyoobok Lee (leekb@kif.re.kr)
1. Background
During the global financial crisis, market interest rates
and bank lending rates decreased along with BOK’s
base rate adjustments. But non-banking financial cor-
porates maintained high lending rates, and it burdened
low income households who were the main client base
for nonbank financial companies. Especially, since H1
2010 the high lending rates of non-banking financial
companies have been socially criticized.
2. Current Lending & Deposit rates ofNon-banking Financial Corporates
(1) Lending Rates
Recently, overall lending rates of mutual credits and
credit unions are 6~8% and those of savings banks and
capital services companies are hovering around 15%,
which is 7~10%p higher than those of deposit banks.
But if considering only credit loans, such as excluding
corporate loans and installment financing, the figure
would increase higher than 15%. For example, capital
services’ credit loans rates by weighted average was
29.46%.
Viewing the credit loans rates by credit ratings, capital
services companies’ interest rates for higher ratings
group was approximately 20%. On the other hand, the
rates for lower ratings group was late in the high 30%
range. Also while savings banks lending rates for
higher credit ratings was 15%, those for lower credit
ratings was 24%.
Ⅲ. Current Issues 3
Table ⅢⅢ.1 Lending Rates1) by FinancialInstitution
Note: 1) based on newly loans except capital services2) Hyundai, Lotte, Hana, Aju capital services
Source: BOK, FSS.
depositbank
savingsbank
creditunions
mutualcredits
capital services2)
5.66
5.43
5.65
5.85
5.82
5.4
5.45
5.37
5.69
5.75
12.59
11.93
11.74
11.74
12.73
12.31
12.63
13.36
15.21
15.73
8.73
7.91
7.74
7.76
7.83
7.6
7.68
7.54
7.42
7.35
7.66
6.98
6.81
6.9
6.85
6.56
6.57
6.34
6.21
6.16
16.88
14.83
14.95
14.56
15.52
15.07
16.34
15.82
-
-
1Q
2Q
3Q
4Q
1Q
2Q
3Q
4Q
1Q
2Q
’09
’10
’11
Table ⅢⅢ.2 Credit Loans Rates of MajorBanks
Note: 12/1/2010~1/6/2011.Source: Korea Federation of Banks.
min.
average rate of 6 commercial banks
average rate of 5 local banks
average rate of 4 specialized banks
average rate of all banks
max. gap
6.67%
6.40%
5.39%
6.18%
10.91%
9.64%
8.28%
9.69%
4.25%p
3.24%p
2.89%p
3.51%p
Table ⅢⅢ.3 Credit Loans Rates of SavingsBanks by Credit Ratings
Note: including 39 savings banks.Source: Korea Federation of Savings Banks.
ratings 1~3 4~5 6~8 9~10
Max 23.2 34.0 41.8 42.5
Min 8.0 9.5 10.0 11.0
Max-Min 15.2 24.5 31.8 31.5
average 15.0 20.3 23.9 24.1
Comparing each company, the gap between highlend-
ing rates and low lending rates for same credit ratings
of capital services companies was above 10%p for high
credit ratings and those decreased as credit ratings fell,
then finally 6%p at ratings 9. Meanwhile, in the case of
savings banks, the lower credit rating the larger was the
gap, which means that there are various lending rates
for low credit-rating borrowers.
(2) Deposit Rates
Deposit rates of non-banking financial companies was
moving in a range of 4~5%, 1~2%p higher than those
of deposit banks.
Capital services companies usually raised a fund by
issuing corporate bonds of which the interest rate
spread between the corporate bonds (A+) and treasury
bond (3yr) was averaged 1.5%p from January 2006 to
January 2011. During the global financial crisis, the
credit spread increased 5%p as capital services’ corpo-
rate bonds yields rose above 9%, but the spread shrank
to 1.6%p in 2010 as financial market uncertainty eased.
(3) Loan-Deposit Margin
Since the end of 2007, the loan-deposit margin of the
savings banks exceeded those of deposit banks. Espe-
cially in Q2 2011, while the margin of deposit banks
was 2.07%p, those of savings banks expanded to
10.74%p. As a result, the gap between savings banks’
margin and deposit banks’ margin expanded by
8.67%p, meanwhile those of credit unions and mutual
credits were 0.87%p, △0.13%p in Q2 2011.
Current Issues 49
Figure ⅢⅢ.1 Bond Yields of FinancialCorporates1) Ex Banks and CreditCard Companies
Note: 1) capital services corporates are major.
Source: Bond Pricing Online, BOK.
Table ⅢⅢ.4 Deposit Rates1) by FinancialInstitution
Note: 1) based on newly loans except capital services2) Hyundai, Lotte, Hana, aju capital services
Source: BOK, FSS.
depositbank
savingsbank
creditunions
mutualcredits
capital services2)
3.45
2.89
3.11
3.58
3.58
2.93
3.11
3.14
3.58
3.68
5.97
4.91
4.98
5.14
5.23
4.34
4.38
4.4
4.92
4.99
5.52
4.44
4.37
4.8
4.97
4.44
4.25
4.21
4.44
4.7
4.84
4.01
4.05
4.52
4.68
3.97
4.02
3.92
4.23
4.4
5.04
4.87
4.92
5.87
5.04
5.02
4.98
4.27
-
-
1Q
2Q
3Q
4Q
1Q
2Q
3Q
4Q
1Q
2Q
09
10
11
Table ⅢⅢ.5 Loan-Deposit Margin
Note: based on newly loans. Source: BOK.
Bank SavingsBanks
Credit Unions
Mutual Credits
2.17 1.74 1.60 1.58 1.56 1.44 1.35 1.44 1.51 1.41 1.45 2.21 2.54 2.54 2.27 2.24 2.47 2.34 2.232.112.07
5.96 5.85 5.17 5.23 5.29 5.17 4.74 5.28 5.14 5.45 5.42 6.62 7.02 6.76 6.60 7.50 7.97 8.25 8.96
10.2910.74
3.56 3.04 2.21 2.31 2.24 2.20 1.83 2.28 2.34 2.41 2.27 3.21 3.47 3.37 2.96 2.86 3.16 3.43 3.332.982.65
2.79 2.22 2.27 1.80 1.69 1.63 1.53 1.35 1.64 1.69 1.63 2.82 2.97 2.76 2.38 2.17 2.59 2.55 2.421.981.76
4/44/44/41/42/43/44/41/42/43/44/41/42/43/44/41/42/43/44/41/42/4
040506
07
08
09
10
11
Korean Economic and Financial Review [October 2011]50
3. Analysis of Determinant of Non-banking Financial Companies'Interest Rates
(1) Lending Rates
In general, fund-raising expense and credit spread are
important parts of determining lending rates. An analy-
sis of the determinant of lending rates showed that lend-
ing rates of savings banks didn’t response to call rates,
but was closely related with economic growth.
The response of deposit banks' lending rates to call
rates was best and the next was mutual credits, fol-
lowed by credit unions, and savings banks. Meanwhile,
the response extent order of lending rates to GDP
growth was savings banks, mutual credits, deposit
banks, and credit unions, in that order. The cross correl-
ogram of call rates and lending rates, analyzing a time
lag correlation between two variables, resulted in a
similar conclusion.
Savings banks was expected to be sensitive to credit
risk because loans to low credit-rating borrowers was
significant. However, in analysis, it was not. This was
because the savings banks’ lending rates might not
change along with the credit risk as maximum credit
risk was already reflected to the lending rates. Instead,
savings banks diversified its business strategy,
reflected by business conditions, to customers who
considered capital availability to be important.
On the other hand, in the case of savings banks, the
ratio of sales, general and administrative expense to
sales did not influence lending rates.
(2) Deposit Rates
An analysis of the determinant of deposit rates showed
that financial companies’ deposit rates was more
closely related with call rates comparing the correla-
tions of lending rates and call rates. Particularly,
deposit rates of savings banks was closely related with
call rates, more than those of credit unions and mutual
Table ⅢⅢ.6 OLS for Lending Rates
Note: 1) GDP growth used seasonally adjusted q.o.q.growth, 2) call rates and credit risk used q.o.q.change, 3) For solving autocorrelation of residu-als, add AR(1), 4) ***, **, * mean statistically sig-nifiant by level of 1%, 5%, 10%.
deposit credit savings mutualbanks unions banks credits
periods 1Q 2004~ 1Q 2011
call rates 0.892 0.223 0.094 0.263change (8.332)*** (1.834)* (0.643) (2.606)**
GDP △0.126 △0.114 △0.196 △0.126growth (△3.886)*** (△2.457)** (△3.456)*** (△3.326)***
credit risk 0.002 0.002 0.013 △0.003change(-1) (0.371) (0.227) (1.151) (△0.358)
constant0.133 0.078 0.112 0.090
(2.449)** (1.251) (1.525) (1.688)
R2 0.782 0.193 0.427 0.341
R2 0.745 0.058 0.332 0.231
D.W. 1.951 1.871 1.299 1.882
~
Table ⅢⅢ.7 Cross-correlation Between TargetRates and Lending Rates
Note: 1) From January of 2004 to April of 2010.
lag deposit credit mutual savings(month) banks unions credits banks
t=0 0.654* 0.045* 0.175 △0.024
t=1 0.716* 0.126* 0.453* 0.199
t=2 0.607* 0.246* 0.606* 0.209
t=3 0.314* 0.328* 0.695* 0.157
Table ⅢⅢ.8 OLS for Deposit Rates
Note: 1) GDP growth used seasonally adjusted q.o.q.growth, 2) call rates and credit risk used q.o.q.change, 3) For solving autocorrelation of residu-als, add AR(1), 4) ***, **, * mean statistically sig-nifiant by level of 1%, 5%, 10%.
deposit credit savings mutualbanks unions banks credits
periods 1Q 2004~ 1Q 2011
call rates 1.300 0.616 0.960 0.820change (9.741)*** (4.302)*** (5.814)*** (5.783)***
GDP △0.199 △0.172 △0.283 △0.186growth (△4.732)*** (△3.580)*** (△4.921)*** (△3.830)***
credit risk 0.001 0.000 0.001 -0.004change(-1) (0.125) (0.028) (0.065) (-0.384)
constant0.214 0.151 0.271 0.187
(2.998)*** (1.892)* (3.373)*** (2.543)**
R2 0.825 0.530 0.634 0.616
R2 0.795 0.452 0.573 0.552
D.W. 1.877 1.843 2.034 1.965
~
t=0 0.643* 0.340* 0.453* 0.263*
t=1 0.685* 0.608* 0.623* 0.537*
t=2 0.669* 0.734* 0.701* 0.685*
t=3 0.448* 0.771* 0.625* 0.639*
credits, but less than those of deposit banks (deposit
banks > savings banks > mutual banks > credit unions).
These results were similar to the analysis of cross cor-
relogram of call rates and deposit rates.
Meanwhile, the response extent of deposit rates to GDP
growth was savings banks, deposit banks, mutual
banks, and credit unions in that order.
(3) Loan-Deposit Margin
In the case of savings banks, the response of loan-
deposit margin to call rates was best because loan-
deposit margin was calculated by lending rates minus
deposit rates, and affected by the determinants of lend-
ing deposit rates.
While the lending rates of savings banks did not react to
call rates, deposit rates of savings banks was closely
related with call rates. Hence, when call rates fell, the
loan-deposit margins of savings banks greatly
expanded. According to the analysis of loan-deposit
rates, 1%p decrease in call rates made loan-deposit
margins of savings banks increase by 0.86%p, compar-
ing the figure of 0.40%p of deposit banks.
On the other hand, a 1%p increase in GDP growth
raised the loan-deposit margin of savings banks by
0.09%p, 0.02%p higher than those of deposit banks, but
its statistical significance was low.
Consequently, since the recent global financial crisis,
the main reason that savings banks’ loan-deposit mar-
gin expanded more than those of deposit banks was
because of the fall in call rates along with a fall in GDP.
Comparing the periods of base rate increases and
decreases, while the loan-deposit margin of non-bank-
ing financial companies increased more than those of
deposit banks during the periods of base rate decreases,
the margin of non-banking financial companies
decreased less than those of deposit banks during peri-
ods when the base rate was increased. Because the base
rate was decreased recently due to worsened economic
Current Issues 51
Table ⅢⅢ.10 OLS for Loan-Deposit Margin
Note: 1) GDP growth used seasonally adjusted q.o.q.growth, 2) call rates and credit risk used q.o.q.change, 3) For solving autocorrelation of residu-als, add AR(1), 4) ***, **, * mean statistically sig-nifiant by level of 1%, 5%, 10%.
deposit credit savings mutualbanks unions banks credits
periods 1Q 2004~ 1Q 2011
call rates △0.404 △0.479 △0.863 △0.540change (△7.840)*** (△4.291)*** (△5.105)*** (△4.566)***
GDP 0.073 0.073 0.089 0.050growth (4.307)*** (1.791)* (1.394) (1.156)
credit risk 0.001 0.003 0.014 0.002change(-1) (0.361) (0.347) (1.133) (0.227)
constant△0.081 △0.093 △0.160 △0.087
(△2.683)** (△1.621) (△1.906)* (△1.476)
R2 0.757 0.462 0.568 0.515
R2 0.716 0.373 0.496 0.434
D.W. 1.833 1.989 1.511 2.042
~
Table ⅢⅢ.9 Cross-correlation Between TargetRates and Deposit Rates
Note: 1) From January of 2004 to April of 2010.
lag deposit credit mutual savings(month) banks unions credits banks
Korean Economic and Financial Review [October 2011]52
conditions, the lending rates of savings banks were
more sensitive to GDP growth.
4. Conclusions and Implications
Analysis of the determinants of lending rates showed
that lending rates related not credit risk or target rates
but economic condition. Especially, the main reasons
that lending rates of savings banks and capital services
companies are insensitive to a market rates were low
price elasticity of demand and the market conditions
with imperfect market competition and asymmetric
information.
Therefore, enhancing market competition and effi-
ciency through expanding substitutional goods and eas-
ing asymmetric information were needed for reason-
able lending rates of non-banking companies.
Moreover, lowering the ceiling of the legal interest
rates made less interest burden in a short-term view,
and eventually this would give low-income house eco-
nomic stability and help non-banking companies to
enhance the ability of risk management.
B. How to Boost the LaggingHigh Yield Bond Market
Hyungjoon Ray Lim (hjlim@kif.re.kr)
1. Background
As the economy bounced back strongly in 2010 and in
Q1 2011, the credit cycle also took an upturn. Never-
theless, the high yield bond market has still been in dol-
drums. A well functioning high yield bond market is
important: it helps not only firms’ restructuring by
funding leveraged buyouts and merger and acquisi-
tions, but also growth companies to raise capital.
We consider what would be necessary for boosting the
stagnated high yield bond market: realistic investment
protocols of institutional investors, the introduction of
fund credit rating system, enhancing the risk underwrit-
ing of security companies and others.
2. Non-prime (high yield) BondMarket in Korea
It is customary to categorize the corporate bonds into
two groups: investment grade and non-investment
grade. Investment grade bonds range from AAA rated
bonds to BBB- rated ones. They are thought to have
small credit risks and for that reason, most institutional
investment vehicles including mutual funds stipulate
that they invest only in investment grade space. On the
other hand, non-investment grade bonds, or high yield
bonds, with credit rating of BBB+ or below have signif-
icant default risks and therefore investors ask higher
yields for such bonds. In Korea, many investors also
shun BBB+ to BBB- rated bonds, so bonds are often
categorized into prime (AAA~A-) and non-prime
(BBB+ or below). For this reason, we focus on non-
prime bonds instead of non-investment grade bonds in
this report.
The high yield bond market is stagnated compared with
Current Issues 53
Figure ⅢⅢ.2 Trend of Corporate BondsIssuance
Source: FnGuide.
Table ⅢⅢ.11 Issued Amount of CorporateBonds by Credit Ratings
(Unit: KRW bil.)
Note: 2009.3.2 ~ 2010.9.13.Source: FnGuide.
Number of CorporateIssuing amountbonds
Number Ratio Amount Ratio
AAA 240 29.0% 214,745 28.5%
AA 186 22.5% 245,343 32.5%
A 286 34.5% 234,506 31.1%
BBB 88 10.6% 44,647 5.9%
BB 21 2.5% 8,700 1.2%
CCC 6 0.7% 6,350 0.8%
D 1 0.1% 60 0.0%
Total 828 100% 754,351 100%
prime bond market. From March 2009 to September
2010, the issuance of high yield bonds amounted only
to KRW1.5 trillion won, 1.8% of all corporate bond
issuance. Even in terms of non-prime bonds, essentially
further including BBB+ to BBB- rated bonds, only
KRW5.97 trillion worth of bonds had been issued,
which was only 7.9% of all issuance.
The contrast between prime and non-prime sector has
been magnified since 2009. Due to global financial cri-
sis, credit market plunged across various spectrums in
2008~2009. Since then, however, prime bond market
boomed as investors sought higher yield than Korean
treasuries. Owing to the stabilization of financial mar-
ket and economic recovery, in August 2010, the credit
spread of prime bonds fell to 98bp, the pre-crisis level.
On the other hand, the credit spread of non-prime bonds
still hovered around 692bp. This is a unique phenome-
non: even in the US, Europe, and Japan where eco-
nomic recovery was more sluggish than Korea’s, the
non-prime bond credit spread fell back to pre-crisis
level.
3. How to Boost the Non-primeBond Market
Well functioning non-prime bond market is quite bene-
ficial to the economy. Since banks cannot easily finance
leveraged buy-outs, mergers or acquisitions, non-prime
bond market can fill the gap raising capital for firms’
restructuring. In addition, non-prime bond market
could help small, but promising firms to fund for
growth. In such light, we consider how we can boost
the non-prime market.
1) Increasing Institutional Investors'Participation
For the non-prime bond market to take off, expanding
the institutional investor base is critical. Investing unit
is much larger for bonds and non-prime bonds even
contain significant credit and liquidity risks. Therefore,
investing in non-prime bonds require a large pool of
Korean Economic and Financial Review [October 2011]54
Figure ⅢⅢ.3 Liquidity1) and Credit Spreads2)
Note: 1) Increase rate from the same period in the previ-ous year.
Note: 2) Gap between yield rate of each grade corpo-rate bond(3Y) and yield rate of Korean govern-ment bond(3Y).
Source: BOK, FnGuide.
Figure ⅢⅢ.4 Credit Spread between Prime andNon-prime Corporate Bonds1) inMajor Countries
Note: Prime bond’s grade is AA- and non-prime bond’s
grade is BBB- in Korea. Prime bond’s grade is AA
and non-prime bond’s grade is BBB in the others.
Source: FnGuide, Bloomberg.
capital for risk management, which do not suit most
individual investors. Furthermore, even among institu-
tional investors, banks and insurance companies cannot
increase their exposure to non-prime bonds much
because of Basel III and RBC regulation, respectively.
Thus, policy measures to promote the non-prime bond
market have to target pension funds and asset manage-
ment companies.
Pension funds do not have much exposure to non-prime
bonds for now due to their internal investing guide-
lines, which were tightened after the global financial
crisis. Those guidelines are too tight for their risk
appetite and needs to be relaxed. National Pension Sys-
tem is even considering investing in commodities and
with such risk appetite, they do not have to shun low
grade corporate bonds.
Like pension funds, there is little exposure to non-
prime bonds for mutual funds. Even in 2006 when
high-yield funds peaked, high-yield funds amounted
only to KRW1.6 trillion (and prime bonds and trea-
suries took up most of portfolios) and at the end of
2010, they shrunk to KRW40.8 billion.
The reason for such slump is that the terms and condi-
tions restrict the credit rating of individual bond in the
portfolio. It leaves little room for bonds with the rating
below BBB- and to revise this terms, it needs strict ref-
eree from the FSS. Rather than restricting the rating of
each bond, we could use the credit rating of the whole
portfolio, using the credit rating of the fund as a regula-
tory benchmark. Of course, considering rating a time-
varying portfolio is more difficult, we need a careful
introduction.
2) Enhancing Risk Underwriting ofSecurity Firms
For non-prime bond market to mature and develop, the
existence of security firms are essential that evaluates
credit risks, underwrites such risks, and has good repu-
tation and various client networks. Unfortunately, so-
called ‘lowering commission’ practice is still prevalent
Current Issues 55
Table ⅢⅢ.12 Balance1) of High Yield BondFunds
(Unit: KRW hundred mil.)
Note: Setup balance at the end of each period.Source: Korea Financial Investment Association.
2006 2007 2008 2009 2010
Tax free /High yield
0 0 0 0 1
Tax free / Highyield / High Risk
1,854 804 510 378 0
High-yield 13,469 7,071 2,953 1,990 407
Total 15,323 7,875 3,463 2,368 408
that security companies take a loss by underwriting
bonds at higher prices and selling them to investors at
lower prices. Under these circumstances, there is little
room for underwriting high credit risks and thus little
room for no-prime bond market.
Preventing security companies from selling underwrit-
ten bonds at lower than purchased prices for a given
period might help end this practice. Then security com-
panies that lacs risk underwriting abilities would be
crowded out from the primary market and it would
eventually help developing of non-prime bond market.
Security companies can also issue non-prime bonds
backed securities (ABS) and use tranching and ABCP
vehicles. To broaden institutional investor base, reduc-
ing credit and liquidity risks that would involve in
investing in non-prime bonds is necessary. By pooling
non-prime bonds and tranching them, credit risks can
be lowered while ABCP conduits would shorten the
maturity.
3) Improving Credit Rating Agencies
One of the biggest reason why non-prime bond market
has not recovered despite the pick-up in the credit cycle
is the market do not have confidence in the credit rat-
ings attached to corporate bonds. For example, the
default rate of BBB rated corporate bonds was actually
higher than that of BB rated ones for a certain credit rat-
ing agency in 2010. Unless credit rating agencies
impartially and correctly evaluate the credit risks of
corporate bonds, the investor would not readily pur-
chase the corporate bonds that have not negligible
default risks. Regulating and improving the credit rat-
ing agencies has been one of the most difficult task for
financial supervisors and regulators, though.
Korean Economic and Financial Review [October 2011]56
C. Developing SecuritiesLending Transactions inKorea
Young Do Kim (ydkim@kif.re.kr)
1. Concept of Securities LendingTransaction
Securities lending transactions mean financial transac-
tions where security holders (lenders) receive commis-
sions and lend securities to institutions (borrowers) as
an investment strategy. The borrowers should repay the
same amount and the same kind of securities within a
stipulated time. The main purpose of securities lending
transactions to investors is to implement an investment
strategy of preventing default risk and increasing
returns on holding securities. securities lending trans-
actions are closely related to a borrower’s short selling
for arbitrage trading that makes profits by using price
differences among securities or financial markets.
Securities lending transactions were begun to resolve
an increase in default risk that arises due to growing
security market size. In terms of supply side, securities
lending transactions have been developed as beneficial
owners of securities carrying out the role of suppliers
through various improvement of the market system. In
the demand side, it is closely related to the development
of a derivatives market.
Most security lending transactions occur to cover short
selling position and there are diverse participants such
as lenders, borrowers, intermediaries, etc. Difference in
transaction attributes and commission systems arises in
relation to various transaction channels between
lenders and borrowers. Also, details of security lending
transactions are various according to the type of collat-
eral.
Current Issues 57
Figure ⅢⅢ.5 Participants of Security LendingTransaction and Their Role
Source: Standard & Poor’s
2. Current Status of OverseasSecurity Lending Markets
(1) U.S. market
Security lending markets in U.S. is mainly operated by
private institutions, and the roles of participating insti-
tutions are mixed. Regulation on the security lending
terms and conditions are based on the mutually agreed
contracts. However, there are some binding regulations
to assure transparency and fairness of transactions.
FRB’s ‘Regulation T’ specifies obligation to submit
collateral. Also, banks are under regulation by FRB and
OCC and broker-dealers must comply with ‘Security
Exchange Act’, ‘Consumer Protection Law’, and regu-
lation by self-regulatory organization.
U.S. has a much bigger security lending market com-
pared to other countries. The size of stock lending mar-
ket in the U.S. is 367 billion dollar and it is 19 and 13
times bigger than that of U.K. and Japan, respectively.
Also, the size of the bond lending market in the U.S. is
9 times bigger than U.K. market.
(2) U.K. and Japanese market
The securities lending market in the U.K. has devel-
oped as borrowing institutions were expanding in 1974.
CREST (Center of Securities Depository) provides col-
lateral management services related to securities lend-
ing. In U.K., the collateral ratio using securities is about
70% and this ratio is higher than the cash collateral
ratio, which is popular in other countries, such as in the
U.S. In the U.S., the collateral ratio using cash is about
95%.
The Japanese securities lending market had developed
with increasing demand for arbitrage trading as Japan-
ese corporations issued convertible bonds and equity-
linked warrants in the middle of 1980s. However, the
size of securities lending markets is decreasing due to
the recent financial market downturn.
Korean Economic and Financial Review [October 2011]58
Figure ⅢⅢ.6 Major Countries' Security LendingTransaction Trend
<A. Stock lending transaction>
<B. Bond lending transaction>
Source: The Securities Lending Committee of RMA,
Quaterly aggregate Data.
3. Current Situation In Korea
There has been continuous system improvement to
develop securities lending since August 1996 when
securities lending was started by the Korea Securities
Depository (KSD). Supervisory authorities promoted
the improvement of a disclosure system to reduce
asymmetric information problems among participants
in the financial markets. Despite such continuous mar-
ket system improvements, there are still inconve-
niences to check details on each securities lending
transaction under the ‘Capital Market Law’, which
governs the securities lending market.
There are major regulations on securities lending trans-
actions under the ‘Capital Market Law.’ For securities
to be lent through intermediaries, borrowers must pro-
vide ‘securities or cash’ as collateral to intermediaries.
In the case of direct security lending, parties determines
terms and conditions of a transaction including collat-
eral for each transaction. In Korea, securities that are
possible for lending are limited to listed stocks, listed
bonds, ETF, and so on.
Currently, participants in Korea’s securities lending
market are clearly classified into lenders, borrowers,
and intermediaries unlike in the U.S. Lenders include
foreign investors, pension funds, asset management
companies, insurance companies, banks, security com-
panies, among others. And borrowers mainly include
foreign investors, securities companies. Intermediaries
such as KSD and Korea Securities Finance Corporation
(KSFC) perform the work related to intermediation of
securities lending transactions and management of
securities and collateral. Securities companies are also
included in intermediaries that are in charge of interme-
diation of loan transactions only.
(1) Stock lending Transactions
The balance of stock lending transactions shows an
upturn trend again after rapidly decreasing due to the
prohibition of short-selling during the global financial
crisis and the large redemption of stocks by foreign
Current Issues 59
Figure ⅢⅢ.7 Size of Stock Lending Transactionin Korea
Source: KFI A.
Figure ⅢⅢ.8 Size of Bond Lending Transactionin Korea
Source: KFI A.
investors for security lending. Domestic stock lending
transactions are mostly conducted through the KSD.
Foreign investors take an absolutely high proportion of
loan and borrowing in stock loan transactions.
Recently, domestic investors’ proportion of loan and
borrowing of stock loan transaction has been increas-
ing.
Most of the stocks that are borrowed by foreigners are
presumed to be related to short covering. Foreign
investors use a covered short-selling strategy as the
purpose of arbitrage or hedging while domestic
investors are passive in a covered short selling strategy
overall.
(2) Bond lending Transactions
The balance of domestic bond lending transactions has
shown a continuous increasing trend and it is expected
to grow consistently. Unlike stock lending transactions,
bond lending transaction are mainly conducted through
the KSFC. Also, domestic investors take absolutely
high proportion in loan and borrowing of bond lending
transactions.
Foreign investors’ bond lending transactions are mostly
conducted among foreign investors due to the unique
practice of domestic bond market participants. The rea-
son why foreign investors are not participating much in
bond lending transactions is that it is unattractive for
them to execute a bond spot-forward related trading
strategy.
4. The Way To Develop SecurityLending Market
Generally, the effect of the security lending market to
the capital market can be summarized as enhancing the
liquidity of the market and function of price discovery.
In the industrial aspect, it contributes to the advance-
ment of the domestic capital market by giving an
opportunity to increase revenue to borrowers and
lenders. Therefore it is beneficial to develop it. In order
Korean Economic and Financial Review [October 2011]60
Table ⅢⅢ.13 Lending and Borrowing byForeign Investment in KoreanBond Lending Market
(Unit: billion won)
Source: KFI A.
lending borrowing net lending
0.0
0.0
0.0
1,520.3
1,452.6
1,030.1
671.8
564.5
0.0
702.6
9.5
1,520.3
1,452.6
1,030.1
671.8
564.5
0.0
702.6
9.5
0.0
0.0
0.0
0.0
0.0
1Q
2Q
3Q
4Q
1Q
2Q
3Q
4Q
2009
2010
to develop it in Korea, there are some things to con-
sider.
First, it is required to verify market efficiency under the
current market system where it approves exclusiveness
of particular institutions as well as competitiveness
among institutions. And it is considerable to attempt to
integrate or unify systems which are varied by interme-
diaries, if possible. Second, through introduction of
hedge funds that use a short-selling strategy most dar-
ingly, we need to increase demand for borrowing. Also,
domestic banks should develop business models, like
the trust banks in the US. Third, it is necessary to alle-
viate regulations on short selling, such as limitation on
short selling of stocks in the financial sector. Also, we
need to consider a way that can increase overall supply
and demand. Introduction of automatic loan service to
prepare default risk and improvement of the system
related to a stock purchase right regarding stock lend-
ing may be key aspects to activate the market. Finally,
as a security lending transaction is closely related with
short-selling, it is necessary to confirm that market dis-
turbance due to short-selling is not severe.
Current Issues 61
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