The Role of the World Bank in the Financial Development of Korea

 

A paper based on author's statement in the conference held in the Asian Development Bank, Manila, Philippines, November 18-22, 1984.

 

             The scarcity of domestic savings is one of the principal hurdles that the developing countries need to overcome in their quest for sustained economic growth. Of course, international financial organizations such as the World Bank and Asian Development Bank (ADB) have been of enormous assistance to the developing countries in helping to solve this problem. Such organizations provide an indispensable supplementary means of raising funds in the developed countries for utilization in the developing nations. The bulk of these loans has gone directly for infrastructural projects such as highways, harbors, dams, schools, hospitals and so forth.

Projects of this nature are obviously valuable and necessary, and when I was a government official I spent much of my time soliciting these kinds of project loans for Korea. Yet it often occurred to me that at least some money could have been utilized by those international financial organizations in helping the banking system in the developing countries strengthen their own resource-mobilization capabilities. Such an approach, it seemed to me, would be a better and more fundamental way to address the problem of the scarcity of domestic resources than simply doling out project loans. There is a saying, attributed to Confucius, that neatly encapsulates this idea: If it is good to feed a poor man by giving him fish, it is far better to teach him how to catch fish by himself.

Fortunately, the World Bank was receptive to this concept, and eventually its affiliate, the IFC, involved itself through equity participation in the formation of two new financial institutions in Korea. The first of these joint ventures was the Korea Development Finance Corporation (KDFC) established in 1967. Four years later it was followed by the formation of the Korea Investment and Finance Corporation (KIFC). The KDFC proved to be so successful that it was expanded and reorganized into the Korea Long Term Credit Bank in 1980. Between 1975 and 1982, the bank's total assets, in constant 1975 prices, increased at an annual rate of 25 percent, thus making a substantial contribution to domestic capital formation in Korea.

I am happy to say that the KIFC turned out to be another success story. As I noted a moment ago, the World Bank-affiliated IFC was also instrumental in the creation of the Korea Investment and Finance Corporation. Indeed, the IFC took the initiative in encouraging several leading investment houses-Goldman Sachs, Bankers Trust, Nomura Securities, and the Private Investment Company for Asia-to join with itself and various Korean investors to establish the KIFC.

In retrospect, it is clear that the birth of the KIFC marked the beginning of a new and dramatic stage in the development of Korea's nonbanking financial market-often called the "second financial sphere." The fledgling KIFC began operations with a simple form of discounting: issues of dealers' short-term notes and discounting of short-term corporate notes of less than 90 days maturity. This had the immediate effect of attracting a large volume of funds from the unorganized "curb market" by offering higher returns than could be obtained through the commercial banking system, then under strict government control.

By 1973, the success of the KIFC had prompted the formation of other short-term finance companies (STFCs), with the approval of the Finance Ministry. Since then, the scope of these companies' operations has gradually been widened to include such new financial services as factoring notes, repurchase agreements for traded bonds, dealings in CDs issued by commercial banks, and cash management services. Their phenomenal success can be judged from the fact that, to date, some 40 such nonbank financial intermediaries have come into existence.

The IFC additionally contributed to the development of the Korean capital market by extending technical and financial assistance when the Korean government undertook a drastic reform of the securities market. Although the IFC did provide a loan to the Korea Security Finance Corporation to help ease the transition, this was not nearly as important a contribution as the technical advice and support that the IFC gave the Finance Ministry. Such nonfinancial assistance was especially valuable at a time when powerful vested interests were mounting a major campaign against the ministry's reform program.

Eventually the resistance was overcome, and the government secured passage of the Public Company Promotion Law in 1972, which signified a turning point in the evolution of the securities market in Korea. Since then, the number of private companies listed on the Korea Stock Exchange has increased from only 50 in 1972 to 328 at present, and the total volume of bonds outstanding with three-to-five-year maturity periods stood at 4,371 billion won, or almost $5.4 billion-accounting for more than 15 percent of total domestic borrowings by Korean companies.

I must say that the spectacular history of Korea's securities market was not, in my view, given adequate treatment in the ADB's Country Report on Korea. Such an omission is especially regrettable as the IFC's role in that development might be of some relevance to the issues under discussion in this forum. Be that as it may, I have chosen to discuss Korea's experience in this regard in order to underscore the critical role that international financial organizations like the IFC can play in the sound development of financial institutions within the developing countries. As our experience clearly demonstrates, financial support is an aspect of that role, but probably not the most important one. Even more important are the managerial expertise and sound practices that the IFC and similar organizations can bring to bear during the crucial early stages in the growth of new financial institutions in developing countries.

Surely, the problems involved in modernizing the developing countries' financial markets and institutions are extraordinarily difficult and complex. At the same time, I would like to suggest that the ADB should avoid becoming overcautious in making direct loans in conjunction with technical assistance or institutional reforms that might be undertaken by the government or private sector in developing member countries.

My belief in this regard is based on several considerations. First, the amount of money involved need not be large. Even symbolic equity participation by an international financial institution or its affiliate would serve to enhance public confidence in the recipient financial institution of the member country. And public confidence is one of the surest foundations on which any financial institution can be built.

Second, the actions of an international financial institution can have a powerful "demonstration effect" on financial institutions in a developing country, leading them to accept innovative banking practices and techniques more readily than would otherwise be the case. There are numerous examples of such techniques and practices that could and should be emulated by the developing countries. These include advanced methods of developing and marketing savings instruments, project evaluation techniques, creditworthiness assessment techniques, sound banking procedures of various kinds, and many others.

In short, if the government of a member country is truly committed to breaking through the traditional inertia that so often bedevils the financial sector in developing countries, then the Asian Development Bank can and should help it to do so through equity investment or direct lending in conjunction with a technical assistance program. The ultimate goal of such assistance is, of course, the creation of a self-sustaining savings-investment process in the country in question.

By so doing, the international financial organization can, I believe, most effectively husband its own scarce capital, while at the same time sowing the seeds of a bountiful financial harvest in soil that has for too long remained uncultivated.