Current Banking Regulations in Korea
on the Legal Perspective
Byung-Tae Kim*
I. IntroductionII. Korean Banking System in General
1. Banking System and General Regulations
2. Recent Reforms for Bank Regulation
III. Distinctive Issues on Bank Regulations
1. Bank Supervision / 2. Bank Ownership Regulation
3. Corporate Governance for a Bank
4. Banking Business Regulation
5. Prudential Regulation
6. Foreign Bank Regulation
IV. Conclusion
I. Introduction
The late 1997 financial crisis of Korea has resulted in significant reforms for the financial and banking sectors, including new banking regulatory framework. Korea suffered the serious turmoil in 1997 both as to individual financial institutions and the Korean banking and financial system in general. Since then, Korea has implemented more actively law-based financial reforms. One of more distinctive reforms has been for financial institutions to be consistent with international financial standards or best practices in their regulations. Nevertheless, Korea suffered another serious financial crisis along with the 2007-2008 subprime mortgage crisis of the U.S., revealing its susceptibility to international financial crises. The 2008 financial crisis has also caused another reforminKorea’s ongoing financial and banking regulations.
A look back on the history of the financial sector reforms in Korea shows that the Government’s financial reforms since the early 1990s have focused primarily on financial deregulation and financial market liberalization.[1] Financial reform measures concerned with deregulation have covered interest rate deregulation, expansion of powers of financial institutions and of their sources of funds, managerial autonomy of financial institutions, realignment of business scope, and lowering of entry barriers for domestic and international institutions. Under these financial reform measures, Korea has been prudently attempting to strengthen its financial regulations, particularly since the turn of the 1990s. These financial reforms since the 1990s, especially after the 1997 financial and banking sector reforms, marked the beginning of a new banking system and bank structure quite different from anything Korea had ever had before.[2]
This paper is concerned mainly with these recent law-based banking reforms and current banking regulations out of financial and corporate reforms effected through the banking sector in Korea. In order to get through the banking sector regulationsin Korea, it is important to understand the “Banking Act”of Korea, the most important law for the regulation and operation of the general commercial banks and the foreign banks in Korea. The Banking Act of Korea,which generally governs regulations for banking activities and foreign banks, has been amended up to now to provide bank restructuring, and better bank management and operation of general commercial banks. Amendments to the Banking Act and other relevant legislations have been mainly concerned with overcoming the then-exiting financial crisis and problems, making Korea’s banking and financial institutions safe, sound and competitive, and adopting internationally accepted standards of bank supervision. These amendmentshave strengthened the responsible bank management system through re-regulation of bank ownership and of the non-executive director ratio. The Banking Actprovides the annulment of an approval system in regard to the opening, closing and moving of a bank branch.[3] It also directly regulates the branches and representative offices of foreign banks.
In turn, some core issues for enhancing competitiveness of banking institutions and for promoting sound and safe bank regulations are dealt with as the main subjects in the Banking Actof Korea, which will be also reviewed separately in this paper.
II. Korean Banking System in General
1. Banking System and General Regulations[4]
The Korean banking system has been modernized and developed along with other diversified financial systems for non-banking institutions since the 1950s, and it has been positioned on and regulated by the gradually united financial system of Korea in relation to all the Korean financial institutions including non-banking financial and foreign financial institutions. Historically, Korea’s modern banking system and the creation of a viable banking sector started when the National Assembly approved the drafts for the “Bank of Korea Act” and the “Banking Act” in April 1950. At that time, a new central bank, the Bank of Korea, came into being on June 12, 1950, and the commercial banks began to be reorganized under the Banking Act.[5]
Under this evolving modern banking system, banking institutions of Korea have been developed and liberalized according to the implementation of government-steered economic development plans. Since the early 1980s, however, the Korean Government has pursued a policy of deregulation designed to increase the efficiency of the local financial industry and to cope with the ongoing internationalization of the domestic financial markets[6]. As a result of various economic and political changes, the banking system has been undergoing a slow transition from central control to a more market-driven order. Keeping in step with the previous financial and banking reforms, the consecutive reform measures have focused on the banking restructuring and the new bank supervisory system, especially trying to avoid further difficulties in the banking and financial sectors.
In general, Korean financial institutions consist of six categories: (i) banks (e.g., commercial banks and specialized banks), (ii) non-bank depository institutions (e.g., mutual savings banks, credit cooperatives including credit unions, community credit cooperatives and mutual banking entities, merchant banks, and the postal savings), (iii) financial investment business entities (e.g.,securities and futures companies, collective investment business entities, investment advisory and discretionary investment business entities, and trust business entities),(iv) insurance companies, (v) other financial institutions (e.g., financial holding companies, credit specialized financial companies, venture capital companies, securities finance companies, public financial institutions, and others), and (vi) financial auxiliary institutions.[7]
Banking institutions are further divided into two types according to the objectives and governing laws of each type – (a) the commercial banks which consist of the commercial nationwide banks, the commercial local banks, and foreign banks, and (b) the specialized banks. The principal legal difference between a commercial nationwide bank and a local bank is its geographic business scope (i.e., a nationwide bank having a nationwide operation and a local bank not having a nationwide operation) and its minimum capital (i.e., one hundred billion Korean Won for a nationwide bank and twenty-five billion Korean Won for a local bank).[8] The principal practical difference is that a nationwide bank is normally more efficient than a local bank in scale of operations and level of profitability. Also, a nationwide bank is more active in foreign exchange business, whereas a local bank relies much more heavily on investment in domestic securities for revenues.
A foreign bank in Korea including its branch and representative office would be covered under one of the commercial bank categories. A foreign bank in Korea is chartered under the Banking Act, and its activities are primarily approved under this Act.[9] For commercial banks, including foreign banks, the formation of new domestic banks or foreign bank branches is subject to the Financial Services Commission(FSC) approval under the Banking Act.[10] Additional banking business such as foreign exchange and trust activities by banks may need another approval by the Ministry of Strategy and Finance(MOSF)[11] under the Foreign Exchange Transactions Act and under the Trust Business Act.
In the Korean banking system, the Bank of Korea (BOK) acts as a central bank in Korea. It performs the usual functions of a central bank, serving as issuer of bank notes and coins, banker to the banking sector, banker to the government and controller of the money supply. Under the Bank of Korea Act, the BOK consists of three key bodies,[12] which are (i) the Monetary Policy Committee, (ii) the Governor of the BOK, and (iii) the Auditor.[13] However, the BOK, a central bank in Korea, has been reshaped by such financial reforms since 1998.
Most importantly with regard to the structure of the BOK, the Bank Supervisory Board, one of the BOK’s bodies responsible for the bank supervision under the old Bank of Korea Act, was removed from the BOK and transferred to the newly established FSC which merged all financial supervisory functions for bank, securities and insurance sectors.[14] Before the financial reforms to the 1997 crisis were carried out, the Bank Supervisory Board of the BOK, which was subject to the instructions of the Monetary Board, was in charge of the supervision and regular examination of banking institutions according to the old Bank of Korea Act. However, under the financial reform of December 1997, the FSC, a newly established committee is now in charge of the supervision and regular examination of banking institutions since April 1998.
Korean Banking Sector and Banking InstitutionsBank Supervisory Entity / Financial Services Commission (FSC) & Financial Supervisory Service (FSS)
Central Bank / Bank of Korea (BOK)
Specialized Banks
(Chartered by SpecialLaws and State-invested) / 5 banks as of Dec. 2011
(KDB, EXIM Bank of Korea, IBK, NFFC, NACF)
Commercial Banks
* Nationwide Banks (Chartered for nationwide operation under the Act) / 7 banks as of Dec.2011
* Local Banks (Chartered for regional operational under the Act) / 6 banks as of Dec. 2011
* Foreign Banks (Korean branches and offices of foreign banks) / 39 branches as of Dec. 2011
Non-bank Depository Institutions / Mutual Savings Banks (98), Credit Unions (957), Community Credit Cooperatives (1,448), Mutual Banking (1,389), Postal Savings (1), Merchant Banking Corporations (1) as of Dec. 2011
Financial Holding Companies / Bank Holding Companies (9), Non-bank Holding Companies (3) as of Dec. 2011
[Source:Bank of Korea, “Financial Institutions in Koreaas of December 2011,” (December, 2011)]
The Korean banking system had basically followed the historic “US Glass-Steagall Act”[15] model with respect to separation of commercial investment banking functions. Commercial banks accepted deposits, issue loans and guarantees, administered trusts and performed limited money management and exchange risk-hedging services, but their ability to market bonds and commercial paper was restricted.[16] However, since Korea legislated the “Financial Holding Company Act (FHCA, Law No. 6274)”[17] in October 23, 2000 which has a legal affiliation among bank holding companies, securities firms, and insurance companies, Korea now has new and different regulations about commercial banking business functions under the new FHCA.[18]
On the surface, the Korean banking system resembles that of many OECD countries; but “behind the scene” government intervention through so-called “window guidance” and other informal channels has remained important and necessary for the development of the country’s economy. Traditionally, the Korean Government was involved directly or indirectly in the “banking system” through the MOFE (now MOSF) and the BOK. Even though the BOK, the primary regulatory agency, sought, in recent years, greater autonomy to become a central bank, the MOFE still had the strongest voice over the functions of the BOK and the banking system. For example, prior to the financial crisis of 1997, the Minister of Finance and Economy presided over the Monetary Board of the BOK which determined monetary policy.[19] It is worth noting, however, that this historically distinctive feature of the Korean Government’s intervention and practical control over “banks” was also important for a governmentally receptive bank supervision and management. The Korean Government controlled many parts of banking activities through the holding of bank stocks or by the appointment of presidents of banks.
However, there were fundamental changes in the central banking system since the new Korean financial reform which was passed at the end of 1997. These changes included reforms for a more sound and competitive banking and financial system and for the liberalization and internationalization of the financial system, focusing on independence for the central bank. According to the new Bank of Korea Act regarding the independence of the BOK and the Monetary Policy Committee (MPC), the Governor of the BOK serves concurrently as the Chairman of the MPC, excluding the governmental intervention by the MOFE (now MOSF). Moreover, in a major effort to liberalize the banking sector, the Government has turned over the ownership of major national commercial banks to private hands. Along with the denationalization of commercial banks, the Banking Act has been revised several times so far to provide banks a freer hand in dealing with their own managerial affairs in order to boost their public accountability by setting upper limits on the ownership of bank stocks per shareholder.
Moreover, at the end of 1995, Korea legislated a new law, the “Depositor Protection Act (DPA, Law No. 5042)” for a stronger bank deposit insurance scheme.[20] In turn, under the new DPA, bank depositors have been protected by a new bank deposit insurance system from January 1, 1997 in the case of any bank bankruptcies. This bank deposit insurance system, in large, still makes the banking system of Korea safe and sound and even stronger.
In addition, in order to reorganize the regulations on the capital markets and financial investment sector, six existing laws addressing the capital markets, including the Securities and Exchange Act, the Indirect Investment Asset Management Business Act and the Trust Business Act, were bundled into the Financial Investment Services and Capital Markets Act (FISCMA) in August 2007 and enforced in February 2009. By encouraging financial innovation and competition through the reorganization of regulations on the capital markets and financial investment companies, as well as expanding the direct financing market through measures such as the cultivation of large-scale investment banks and revitalization of the capital markets, this newly unified Act aimed to create a foundation fostering harmony within the existing system of indirect financing centered around banks.[21] This expansion and systemic reorganization of the capital markets since the mid-2000s has led to a remarkable growth in new securitiesrelated institutions.
2.Recent Reforms for Bank Regulation
Over the past 15 years since the financial crisis in late 1997, Korea has implemented a series of law-based banking and financial reforms in order to secure safe and sound domestic financial markets and institutions. A most recent part of these series of financial sector reforms has been the amendmentsof a major law, the Banking Act, with respect to the prudential supervision and regulationsfor banks.
The Banking Act was enacted on May 5, 1950 (Act No. 911) in order to contribute to stability of the financial markets and development of the national economy by ensuring the sound operation of banks, by elevating the efficiency of their financial intermediary functions, by protecting the depositors, and by maintaining an order in credit transactions. This Act was greatly amended on January 13, 1998 (Act No. 5499) right after the Korea’s 1997 financial crisis and then has arrived at its present form as the result of being amended nine times. The latest amendment was on May 17, 2010 by Act No. 10303.[22]
The Banking Act is an act that ensures the sound operation of financial institutions, the efficiency of the fund brokerage functions, consumer protection and maintenance of the order of credit. The Act covers various kinds of financial institutions except the Bank of Korea, which are engaged in lending funds raised by bearing debts from many unspecified persons through the receipt of deposits and issuance of securities and other bonds.[23] The Banking Act consists of 12 Chapters and 69 Articles.
After the 1997 financial crisis and the IMF arrangement, and the 2008 another financial crisis, there have been several amendments of the Banking Act, in particular,distinctive amendments on April 27, 2002 and May 17, 2010, which will be all summarized as follows.
1) Amendment to the Banking Acton May 17, 2010 (Act No. 10303)
The latest amendment of May 17, 2010 was 27th partial revision. The purpose of this Amendment is (i) to enhance competitiveness andautonomy of banking and asset management through deregulation, (ii) torevamp provisions regarding outside directors and to legislate internalguidelines on company structure in order to uplift managerial transparencyand liability, and (iii) to proscribe unfair business practices such as compensatingbalance in order to reinforce customer protection.
The important changes under the amendment are as follows:[24]
(1)The Amendment details authorization requirements previously containedin the Enforcement Decree, and it demands banks to maintaintheir minimum capital stock requirements after the authorization(Articles 8 and 9).
(2)The Amendment lowers control by substituting ex-ante consultationto ex-post notification for the opening of overseas offices. Theexceptional ex-ante notification may be imposed considering managerialsoundness of a bank, and FSC may ordersupplementation if that notification reveals threat to managerial soundnessand market stability (Articles 13 and 47).