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KoreanEconomic

FinancialReview

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Vol.16 | No.4 | October 2011

President and Publisher

Tae-Joon Kim [email protected]

Contributors (in alphabetical order)

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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


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.


A. Demand and Supply

1. Aggregate Demand

Hyoung-Seok Lim ([email protected])

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.


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%).


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


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


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 ([email protected])

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.


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.


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


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 ([email protected])

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).


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


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).


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 ([email protected])

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.


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..


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-


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.


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


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


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 ([email protected])

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


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


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.


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


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.


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


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


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.


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 ([email protected])

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-


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


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


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 ([email protected])

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


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


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


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.


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


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


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.


Figure ⅡⅡ.9 Beneficiary Certificates at ITMCs

Source: BOK.

C. Financial Industries

1. Banking Industry

Hyoungsik Noh ([email protected])

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.


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


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.


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.


2. Non-Banking FinancialInstitutions

Soonho Lee ([email protected])

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-


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-


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


Lease 74.7 77.5 88.7 96.1

Installment 99.9 93.6 104.2 102.9


Lease 5.7 4.1 4.1 3.7

Installment 2.9 3.4 2.9 2.8


Lease 16.7 16.2 16.2 16.3

Installment 16.3 15.0 13.3 13.8


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-


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


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



Fisheries 6.7 5.6 5.8 5.4

Forestry 7.7 6.3 7.4 7.0



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



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 ([email protected])

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.


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.


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 ([email protected])

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


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,


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


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.


Figure ⅡⅡ.26 Business Performance of Non-Life Insurance Industry


(Unit: Billion KRW)

Figure ⅡⅡ.25 Market Share of Non-LifeInsurance Industry


(Unit: %)


A. Analysis of the Determinantof Non-banking FinancialCompanies' Interest Rates


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


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



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



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


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 ([email protected])

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


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.


C. Developing SecuritiesLending Transactions inKorea

Young Do Kim ([email protected])

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.


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


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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