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Banks Warned on Korean Loans

By Steven Pearlstein
Washington Post Staff Writer
Friday, January 9, 1998; Page G03

Although the Clinton administration has been quietly urging U.S. banks to extend their loans to South Korea, bank regulators said this week that the banks may have to set aside additional funds to reflect the added risk that the loans may not be repaid.

"As the rollovers occur, we would expect the banks to reassess the risks and take the appropriate reserves," said Susan Phillips, the Federal Reserve governor in charge of bank supervision.

The issue of how to classify their Asian loans is a particularly sensitive one for U.S. banks as they try to hammer out a plan with the Seoul government for restructuring the $15 billion to $20 billion in outstanding loans to Korea, most of them to Korean banks.

If the U.S. banks are required to reclassify their Korean loans as riskier, then they may have to take additional charges that could affect their quarterly profit and the price of their stock.

The banks include some of the nation's biggest, such as Citicorp, J.P. Morgan and Bankers Trust Co. All three declined to comment this week on the question of the classification of their Korean loans.

As part of the plan now under consideration, these and other foreign banks would swap some of their outstanding Korean loans for Korean government bonds while receiving Korean government guarantees on the loans they continued to hold. The banks would also agree to extend the terms of the loans in exchange for higher interest rates.

How bank regulators would classify those restructured loans is still unclear. All such discussions between the regulators and bankers are conducted secretly and published regulations give both the banks and government officials wide discretion in categorizing the riskiness of loans.

But contrary to some recent press reports, top regulators said this week that they had given no blanket assurances that the banks would be able to continue to classify their Korean bank loans as relatively riskless.

"We have not given them any guidance" on how any restructuring would be handled, said one senior federal bank official.

In particular, the Fed's Phillips said that if interest rates on the restructured loans were to increase dramatically, that would constitute an unambiguous signal from the marketplace that the loans were more risky.

Phillips also said a promise by the Korean government to guarantee repayment of the loans would not necessarily guarantee that the loans should be treated as low-risk, but would have to be evaluated in the context of the country's overall ability to meet its foreign debts as the crisis in Asia continues to unfold.

"If those economic conditions erode, we would encourage the banks to reassess [the riskiness of the loans] on an ongoing basis," Phillips said.

U.S. banks are supervised both by the Fed, which is the lead regulator of state-chartered banks, and the Office of the Comptroller of the Currency (OCC), which oversees nationally chartered banks. OCC officials declined to comment on the Korean loan situation.

In the 1980s, both the Fed and the OCC came under sharp criticism for failing to blow the whistle on U.S. banks that were driven to the brink of insolvency because of massive bad loans to Latin American governments.

But regulators and bankers say that as a result of reforms made after that crisis, banks today are much better capitalized and have much higher reserves to cover loan losses than they did in the 1980s. And they note that their Asian loans represent a much smaller portion of their loan portfolio than did the Latin American loans.

"The banks are much more sophisticated risk managers now and they have a much bigger cushion to fall back on," said the senior bank regulator who spoke on the condition that his name and agency not be used.

Some critics, however, say the regulators remain much too cozy with the bankers -- citing, for example, the fact that it was the New York Federal Reserve Bank that convened some of the early meetings of the bankers to discuss restructuring the Korean loans.

John Makin, an economist at the American Enterprise Institute who has studied past debt crises, said it would be "the height of hypocrisy" for regulators to allow the banks to treat their restructured Korean loans as anything but highly risky.

Makin noted that Treasury Secretary Robert E. Rubin has publicly chastised Japanese officials for allowing their banks to hide the full extent of their bad loans -- a policy that has helped to cripple the Japanese economy. But Makin fears that U.S. regulators are prepared to do the same thing here out of excess concern for restoring faith in the global banking system.

To a degree, the disagreement about how to classify the Korean loans reflects a deeper dispute about the extent of Korea's problems.

Rubin and other Treasury officials believe that the Korean economy is basically sound and that what it suffers from now is temporary shortage of foreign capital caused by the sudden -- and irrational -- decision by foreign investors and lenders to pull their money out of the country. That panic has temporarily left Korean banks unable to repay their foreign loans.

But Makin and other economists argue that years of mismanagement of the Korean economy have left the country with too many businesses that are fundamentally not viable and unable to repay their loans to Korean as well as foreign banks. Rather than being a short-term liquidity crisis, he argues, Korea is now experiencing a widespread credit crisis that won't go away until investors and lenders acknowledge their past mistakes and take their losses.

A similar "market" approach is advocated by Steven Hanke, a professor of applied economics at Johns Hopkins University, who said the Korean banks should simply admit what everyone knows: that they cannot now repay their loans.

One complicating factor in this case is that if U.S. banks were to write off any portion of their Korean loans, they would put pressure on Japanese banks -- which have much greater exposure in Korea -- to do the same. And because Japanese banks are already in such a precarious situation, that could worsen the financial problems in a far larger economy, one with far more complex interrelationships with the U.S. economy.