This paper undertakes an investigation of the loans extended by Korean financial institutions to their corporate borrowers based on forward-looking criteria - namely, corporations?debt levels and their debt-servicing capabilities ?while focusing on the future size of non-performing loans (NPLs). We define NPLs as loans and credits extended to corporations, whose interest coverage ratio commonly defined as the ratio of earnings before interest and taxes to interest expense is less than 100 percent.

Financial statements from 1998 demonstrate that the NPLs held by listed companies amount to 32.1 percent of their total debts carried. The ratio for unlisted companies in 1997 appears higher than that of listed companies. We classified our sample companies into four groups based on their sizes. The NPL ratios of unlisted companies consistently ascend in the order of second-tier chaebols, SMEs, third-tier chaebols and the top five chaebols. In the case of unlisted companies, the order is slightly different in that the ratio of third-tier chaebols precedes that of SMEs. However, the order in 1998 resembles that of unlisted companies.

Having classified our data by different industries, it has been shown that the NPL ratios of listed companies in industries, such as textile, apparel, non-metal mining products, automobiles, furniture, construction, and chemical have recently experienced relative increases. In the case of unlisted companies, their NPL ratios are high in industries, such as agriculture, fishing, wood and publishing, and transportation and telecommunications.

Our sensitivity test results show that the decline in interest rates by 5 percentage points will reduce the NPL ratio by 13.9 percentage points - from 35.7 percent to 21.8 percent. Although the reduced interest rates and the rebounding economy are alleviating the corporate debt problem to a certain extent, a significant proportion of the Korean corporate sector still remains subject to the various risks, such as commercial and market risks and external shocks. This study has the following policy implications: reflationary macroeconomic policy is the only option in the absence of plausible alternatives; debt restructuring by creditor financial institutions is necessary, given that the effects of cost reduction from lower interest rates and slimming-down efforts are proven insufficient; and additional public resources may be necessary even after the appropriate cost allocation.

Prescription

Executive Summary

Ⅰ. Introduction

Ⅱ. Problem Loans
1. Basic results
2. Breakdown by scale
3. Breakdown by sector
4. Comparison with official numbers of NPLs

Ⅲ. Simulation of the NPL Size
1. Rate of return
2. Interest rates
3. Labor cost
4. Debt-equity ratio

Ⅳ. Conclusions: Policy Implications
1. Reflationary macroeconomic policy is the sole option in the absence of
plausible alternatives
2. Debt restructuring by creditor financial institutions is necessary, given
the effects of cost reduction from the lower interest rates and slimming-down
efforts are proven insufficient
3. Additional public resources may be necessary even after the appropriate cost
allocation
4. Inducement of foreign capital and skills still remain a high priority

References

Korean Abstract