Since the 1990s, the international financial environment has changed fast in terms of globalization, diversification, deregulation and innovation. The development of information and telecommunications technology has led banking institutions to shift from the traditional lending and borrowing activities to multi-financial projects and development of new financial products. Financial engineering has generated various derivatives and international financial transactions have, thereby, been diversified, with the various loosening restrictions on the financial industry.

On the 21st century, the financial industry will have achieved a unified international financial market, due to international financial liberalization and cross-border services under the WTO New Round. With more competition and removal of entry barriers in the international financial market, developed countries have promoted M&As in the financial industry and universal banking system.

After financial crisis, important steps were taken to increase foreigners' access to the banking sector in Korea such as subsidiary and ownership of banks. The benefits of liberalization in banking sector is as follows: to facilitate the exchange of goods and services; to facilitate risk management; to mobilize resources; to obtain information, evaluate firms, and allocate capital; and to provide corporate control. However, there are possible negative effects such as increase in unemployment, higher foreign capital occupancy of the local market, more influence of foreign capital on domestic market and intervention in domestic corporate. Also, freer capital flows have the effect of smoothing consumption over time, and it has to be recognized as the benefit of the liberalization.

We investigated the trend in penetration of foreign banks into the Korean market. Given the regulatory restriction, it has been confirmed that the extent of the penetration remained limited. Foreign banks in Korea have been engaged in foreign currency lending business to Korean corporations and banks, which was funded by their parent offices. Since the share of foreign bank has been too minor to bring about serious changes in charter values of Korean banks and the competitive environment of the Korean banking sector, we focused on their behavioral patterns. We found that their foreign currency lending was neither pro- nor counter-cyclical in contrast to their Korean currency lending which was pro-cyclical. Also interestingly, foreign currency lending of Korean banks turned out to be pro-cyclical.

Foreign banks in Korea were able to provide rather stable foreign currency lending service irrespective of macroeconomic fluctuation of the Korean economy. Foreign banks have more cushions to absorb cyclical shocks specific to the Korean economy than Korean banks. Hence, we argue that allowing commercial presence of foreign banks should be expected to be beneficial in this regard.

It is too early to make a comprehensive assessment of the impact of the liberalization of banking service. However, we conjecture that the ongoing restructuring and entry of foreign banks will make the domestic banks more competitive. In order to survive, management should be independent and efficient. In other words, The Korean banking services should establish the responsible management system and asset soundness. Also, financial infrastructure should be established through improvements in accounting, credit ratings and payment system. The range of banking services needs to be enlarged through development of various products and management skills, along with M&As and joint business with other banks. Consistent market liberalization will more rapidly drive financial globalization. This will lead to the advanced financial institutions as in developed countries.

Executive Summary

I. Introduction

II. Review of Liberalization of Banking Sector in Korea
1. Liberalization in the Pre-crisis Period
2. Liberalization in the Post-crisis Period

III. The Characteristics of Foreign Bank Operation
1. Domestic Bank
2. The Performance of Foreign Banks
3. Evaluation

IV. Effect of Foreign Entry
1. General Discussion
2. The Role of Foreign Entry: Cyclical Properties of Foreign Bank Lending

V. Conclusion

References

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