Time to End State-Directed Finance That Stifles Growth

The Ills of the Industrialization Era Distort Resource Allocation

The Financial Industry Lags Behind and Lacks International Competitiveness

Banks Must Be Given Autonomy in Management, Including Interest Rate Decisions

The government continually intervenes in and controls bank interest rates. At one moment, it tells banks to lower rates; at another, it tells them to raise them. Recently, an odd phenomenon has emerged in which banks’ deposit rates are falling while lending rates are rising, and this is because the government is pressuring banks. Of course, if savings increase in the market while demand for loans rises, deposit rates can fall and lending rates can increase. But the current situation is not the result of autonomous decisions by market participants. It can only be explained as the result of government pressure on banks to raise lending rates.

In general, deposit rates are determined by each bank based on the Bank of Korea’s base rate, market rates such as COFIX (Cost of Funds Index), and bank debenture rates, while also taking into account the bank’s funding position and management conditions. Lending rates are determined by adding each bank’s own spread to COFIX or bank debenture rates. Thus, deposit rates basically follow trends in the Bank of Korea’s base rate or market rates, while lending rates fluctuate according to market rates and spreads. The Bank of Korea has continued to hold the base rate steady, and market rates have recently been falling. Accordingly, both deposit and lending rates should be declining. Yet lending rates are rising. This can only be explained by government pressure on banks to raise lending rates.

The reason the government has pushed banks to raise lending rates is the rapid increase in household debt. But it was the government itself that created the conditions for the surge in household debt. The irony could hardly be greater. Last year, in an effort to stimulate the real estate market, the government pressured banks to lower lending rates and postponed until this September the implementation of the second-stage stress DSR regulation, which had been intended to curb growth in household lending. As a result, household loans—especially mortgage loans—expanded rapidly, and household debt surged. Realizing belatedly that excessive household debt could threaten economic growth and financial stability, the government then hurriedly pushed for higher lending rates in order to suppress household borrowing.

Interest rates are also prices. Just as government control of or interference in the prices of ordinary goods creates mismatches between supply and demand and wrecks markets, interference in and control over interest rates distort the financial market and endanger the economy. Artificial control of interest rates also causes income redistribution among economic actors. When deposit rates fall while lending rates are pushed up, as they are now, interest income from savings declines, while people who need to borrow must pay higher interest, increasing the burden on ordinary citizens. Meanwhile, banks’ profits rise as the spread between deposit and lending rates widens. In other words, wealth is being transferred from ordinary people to banks.

Despite these harmful effects, the background to the government’s interference in and control over bank interest-rate decisions lies in the deep-rooted bad practice of state-directed finance. The history of state-directed finance in Korea runs very deep. Its origins lie in the financial system established in the 1960s and 1970s to support economic development. On the logic that the government had to allocate resources directly in order to support economic growth, it became deeply involved in the management of financial institutions. As a result, not only was resource allocation distorted across sectors, but the efficiency of bank management was also undermined. Recognizing these side effects, the government undertook a series of financial liberalization measures starting in the 1980s, but state-directed finance has not disappeared and continues to cause economic problems.

State-directed finance has hindered innovation, locking banks’ profit structure into one centered on interest income and leaving the financial industry more backward than other manufacturing industries, while also weakening its international competitiveness. As is well known, Korea’s TVs, mobile phones, semiconductors, and automobiles are highly competitive internationally. Samsung Electronics, LG Electronics, Hynix, Hyundai Motor, and Kia are all among the world’s top 10. Yet not a single Korean bank ranks among the world’s top 50 banks. In The Banker’s “Top 1000 World Banks” ranking released based on 2022 performance, KB Financial Group was the highest-ranked Korean institution, at 60th.

Recently, with the development of information and communications technology (ICT) and artificial intelligence (AI), the global financial environment has been changing rapidly. Under state-directed finance, banks’ autonomy and creativity have been weakened, making them unable to respond effectively to changes in the global environment. Resources are also not being put to productive use, thereby harming economic growth. To respond effectively to the rapidly changing financial environment, develop the financial industry, and promote economic development through financial progress, state-directed finance must be dismantled. Bank management, including interest-rate decisions, must be left to the autonomy of banks.

Jaewook Ahn

Emeritus Professor, Department of Economics, Kyung Hee University

Chairman, Center for Free Enterprise (CFE)

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Original title: 성장 막는 관치금융 이젠 청산해야

Author: Jae-uk Ahn

Date: 2024-09-09

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=press&idx=26857