Debate grows over 4% rule on investment banks

The law that strictly forbids nonfinancial companies, or manufacturers, from owning more than a 4 percent stake in banks has been a source of debate here over the years.

It has constantly been discussed not only in the financial and commercial sectors, but also in politics and even during presidential campaigns, with the gap between those arguing for continuous ownership restrictions and those for deregulation growing wider.

The law under the Banking Act, known as the 4-percent rule, is once again being highlighted amid the emergence of investment banks and internet-only banks.

As those two are starting to invade the business turf of commercial banks, banks are arguing that the country should equally enforce the law on them, especially securities companies that are about to become investment banks.

Regulators have come up with a policy that will allow investment banks with capital of over 4 trillion won to provide loans to innovative companies with some portion of the capital raised from investors of their short-term commercial papers. This is part of the efforts to boost more capital flow into venture firms and small- and medium-sized enterprises.

Since investment banks are about to conduct loan services, a business that traditionally belonged to commercial banks, the country should keep them in check with the 4-percent rule, lenders argued.

But it seems the Financial Services Commission’s (FSC) new chairman Choi Jong-ku stands against applying the rule on investment banks as he said during a confirmation hearing that there are no cases overseas where such a law is enforced on the investment banking sector.

His reason was that the characteristics of commercial lenders’ customer deposits and investment banks’ capital from investors are entirely different. The former needs to be protected, while the latter is not risk-proof.

As for internet banks, he said that the law needs to be deregulated to boost innovation and competition.

Meanwhile, President Moon Jae-in is for maintaining the law strictly as he indicated during his presidential campaign and in his five-year economic policy.

“It is too early to see how this is going to unfold. At this point, it seems the presidential office and regulators have not yet coordinated on this issue,” said a financial industry source.

“Objectively speaking and asking, should we really relax this rule just because countries such as the United States and Japan are not applying it as strictly as we do? Korea’s market is unique in its own way because we have chaebol. We need to cautiously study more the effects of the law or deregulation with data.”

Chaebol, ironically fostered by the Korean government to speed up development in the 1970s and 1980s, have become larger than the state.

With a policy protecting them from foreign competition through high tariffs and encouraging reverse engineering, chaebol, or conglomerates, were also given easy access to loans whenever they needed them.

Banks attracted customers with high interest rates, and lent the money to conglomerates.

Then, the Asian financial crisis in the late 1990s erupted, exposing banks and chaebol to high debt vulnerabilities. A decade later, Lehman Brothers collapsed.

The importance of the rule separating commerce and finance has since been further stressed to prevent conglomerates from exploiting and misusing the banks like their own piggy banks.

Also, calls for tighter regulations on investment banks have been raised.

Paradigm shift or same old

Korea faces structural economic problems, and needs innovation to solve them.

This means that more capital needs to flow into creating innovative or venture companies, and loans from banks and investment from venture capital funds are not enough to change the economic paradigm.

This is where the government hopes investment banks could come in and fill the gap.

And the issue of the 4-percent rule — whether to loosen it up or not for internet-only banks such as Kakao’s Kakao Bank and KT’s K bank — is being debated as those tech conglomerates face difficulties in raising and injecting their capital into those banks for expansion.

This was also a problem for commercial banks because the 4-percent rule hindered them to raise capital outside of their industry.

Some industry sources argue that the rule has been highly rigid, and that having more options to financing in addition to commercial bank loans and VC funds will be good for new industries such as startups.

The question remains whether investment banks are willing to take all the risks to provide loans to startups or innovative companies that have the possibility of failing 99 percent of the time.

“Money goes where it can make more money. In this country, the pattern of it has particularly been in the form of a herd behavior. We can notice this in stocks and real estate,” said a finance scholar, who asked not to be named.

“Will investment banks bet on startups, now that they’ve slowed down after the hype in the former government, when they rely on trust and reputation as being successful bankers for continuous operations? The problem we also need to address is commercial bank’s lending practices.”

Banks and VC funds do not have insufficient money for innovative companies.

The problem is both from supply and demand.

The number of entrepreneurs is decreasing as people seek stability in the face of an uncertain future, as seen from the recent surge in applications for public sector jobs.

Also, banks’ usual requests for real estate as collateral before loan extensions has made it difficult for entrepreneurs to approach them for startup funds.

Young entrepreneurs who seek money to launch their startups cannot provide any assets as collateral for loans, other than their intellectual properties and technologies.

But banks do not have the capacity to measure them as collateral.

This is why banks just stick to low-risk lending especially to households whose debt skyrocketed to top 1,400 trillion won.

Banks made a lot of money out of this in the first half of this year, which is expected to be scrutinized by regulators.

State-run credit guarantee agencies such as Korea Credit Guarantee Fund and Korea Technology Finance Corp. have usually stepped in to help guarantee startups’ bank loans.

But still, skepticism remains whether the 4-percent regulation or deregulation could alter herd behavior in this small financial market.

“More and more we are seeing money put into certain things rather than in those that pose high risks and uncertainty. Investments are mostly not made in early-stage startups but in companies that can show high numbers such as sales and customers,” said a venture tech industry source.

Should we really relax this rule just because other countries are not applying it as strictly as we do? We need to cautiously study more the effects of the law or deregulation.