Michael Pomerleano The World Bank Regional Workshop on NBFIs in Africa December 9 – 11, 2003

1. Regulatory and Developmental Problems Raised by the Concentration of Wealth – Lessons from East Asia Michael Pomerleano The World Bank Regional Workshop on NBFIs in Africa December 9 – 11, 2003 Mauritius

2. Recurring themes in East Asia • Large family control in more than half of East Asian corporations. Significant cross-country differences do exist, however. Corporations in Indonesia and Thailand are mainly family-controlled. And state-control is significant in Indonesia, Korea, Malaysia, Singapore, and Thailand *. • Interlocking ownership structures • Ownership structures where the economic benefit is higher than the actual ownership (voting rights consequently exceed formal cash-flow rights); , cross guarantees . • Monopolization of Financing: Bank Lending, Corporate Bond Issuance, Equity Issues Source: Who Controls East Asian Corporations, by Claessens, Djankov and Lang, 1999

3. The Case of Indonesia, Thailand, Malaysia: Concentration of ownership is rampant and free float is minimal

4. The Case of Indonesia: Interlocking group ownership structures affiliated with banks such as BCA… 80% of credit flowed to the tops 20 groups

5. The Case of Korea • In Korea, the Growth of NBFIs Had Been Very Rapid Until 1997 Crisis • The share of NBFIs in domestic financial market became larger than banks by late-1980s . • The Rapid Expansion of NBFIs was owed to a large extent to regulatory arbitrage • NBFIs were not subject to directed credit program. • NBIFs were privately-owned (many by chaebols) • Interest rate control on NBFIs’ products was less restrictive • Supervision over NBFIs was loose

6. Growth of Banks and NBFIs Credit

7. Top-Five Chaebol Monopolization of Financing • Bank Lending • Corporate Bond Issuance • Rights Issues • Commercial Paper…

10. Balance Sheets of Big Three Investment Trust Companies (owned by the chaebols) vs. Regional Investment Trust Companies (Unit: KRW billion)

11. Trust Assets of Investment Trust Companies and Investment in Big Five Chaebols' Securities ….lending was equally concentrated…. (Unit: KRW billion) !!!!!

12. Interest Rates Movement and the Growth of Investment Trust Companies

13. Change in the Structure of Financial Market 100% Corporate Bonds 90% Gov., Public & Financial bonds 80% 70% Investment Trust Mutual Finance 60% Credit Unions Merchant Bank 50% Mutual Credit 40% Insurance 30% Money in trust 20% CD 10% Time & Savings Deposits 0% 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 Jul-99 Jul-00 Oct-00 Jan-99 Jun-99 Jan-00 Jun-00 01-Jan Nov-99 Aug-00 Dec-99 Dec-00 01-Mar May-99 May-00

14. The Korean Experience suggests : • Developments of securities markets and NBFIs that allowed the top 5 chaebol to control the NBFIs sector was fraught with peril and lead to fragility. • The development of NBFIs needs to be based on a solid regulatory framework. • ⇒ ‘spare tire’ can also get flat.

15. Korea’s Response • Consolidation of troubled financial Institutions • Priority was given to merchant banking companies (MBCs) • There was gradual strengthening of regulatory rules on insurance and small savings institutions • Investment and Trust companies(Investment Trust Companies) were largely left out of the focus of restructuring until the Daewoo collapse (July 1999), but regulation strengthened since 1999. • Reorganization and consolidation of supervisory institutions after the crisis in Korea

16. Jun.2001 Types of Institutions Financial Restructuring License Merger Dissolution Total Percent New End of 97 Revoked % established At Jun.2001 Commercial Banks 36 5 6 - 11 33.3 - 25 NBFIs 2,068 116 142 321 579 28 50 1,539 Merchant Banks 30 22 5 - 27 90 1 4 Securities Companies 36 5 1 1 7 19.4 16 45 Insurance Companies 50 5 6 4 15 30 3 38 Investment and Trust Companies 30 6 1 - 7 23.3 6 29 Mutual Sav. &Finance Companies 231 67 26 25 118 51.1 12 125 Credit Unions 1666 2 102 291 395 23.7 9 1280 Leasing Companies 25 9 1 - 10 40 3 18 Total 2,101 121 148 321 590 28.1 50 1564 Consolidation of Troubled Financial InstitutionsJune 2001 source: MOFE, 2001.8

17. Reorganization and consolidation of supervisory institutions after the crisis in Korea Central Bank (BOK) MOFE Insurance Banking Credit Unions Securities Special Financial Institution FSC FSS

18. What can be concluded from the East Asia experience? Some concluding thoughts - Part I The impact of large financial institutions and large corporates on regulatory policy needs to be recognized as well. Their powerful influence can shape public policy initiatives. Elite firms resist policy initiatives that are detrimental to their interests. It often leads to regulatory capture, and self serving policies. • A weak infrastructure leads banks to favor lending to large well established firms (“name” lending… fewer information and enforcement problems) . Therefore credit is concentrated.. It leads to monopolistic practices, lack of competition, and lack of innovation. • A deficient underlying infrastructure- i.e., the necessary legal, enforcement, information and supervisory capacity- inhibits access to credit for all firms (as well as SMEs).

19. What can be concluded from the East Asia experience? Some concluding thoughts - Part II • A sound “arbitrage proof” regulatory framework is essential; • Groups- be it chaebols in Korea, groupos in Latin America or any others- that have banks and NBFIs as part of the group structure…in the past it invariably lead to vulnerabilities and occasionally to crisis; • Policies designed to increase the distribution of ownership – such as the development of institutional investors- will have a salutary impact on stability. • For discussion…. Your reactions?