Kfb Risk Management

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Risk Exposure and Risk Management at Korea First Bank
George Allayannis
Darden Graduate School of Business, University of Virginia

World Bank Conference Washington DC, May 2003

KFB’s Overall Performance
Assets have been declining over time from 46,115 to 33,498 (Ex. 1) A large part of the decline in assets is due to the decline in loans from 20,208 (‘96) to 15,025 (‘98), as well as Customers Liabilities on Guarantees [4,475 (‘96) to 1,466 (‘98)] Not surprisingly, Deposits are down from 26,910 (‘96) to 22,478 (‘98) Retained Earnings have declined precipitously from 446,446 (‘96) to (1,914,597) (‘98)

KFB’s Overall Performance
Large decline in stock market price (see Figure 1); significant decline that cannot be explained by decline in Korean market (or the Korean Finance index) during the same period (see Figure 1 and 2) Consolidated net loss increase from (39,511) in ‘96 to (2,731,029) in ‘98 (Ex. 2) Interest expense went up from 2,718,878 in ‘96 to 3,158,489 in ‘98 Other operating expenses shot up as well from 726,742 in ‘96 to 2,932,784 in ‘98 Large decline in interest and dividends on securities for sale from 1,207,088 in ‘96 to 356,054 in ‘98

KFB’s Credit Risk (A)
KFB’s main exposure to business loans In ‘98 KFB has a slightly more diversified loan portfolio (% of total loans in the top 5 industries down to 37.4% from 44.3% in 96) (Ex. 4) In ‘98 KFB has a smaller percent of loans denominated in foreign currency than in ’97 (32.4% vs. 41.2%); FX loans could provide some diversification from Korean market, but at the same time, potential FX risk

KFB’s Credit Risk (B)
However, top industries of KFB’s loan portfolio highly correlated (e.g., correlation between chemicals and textile (construction) 0.95 (0.92); wholesale and construction: 0.97) (Ex. 5) (see also Figure 3) Bad loans and non-performing loans as a percent of credits have increased significantly from 1.2% (6.7%) in 96 to 8.7% (20.4%) in 1998 (Ex. 6) BIS capital ratio significantly higher than competitors (e.g., in ‘98 (1.27%) versus 7.92% for Hanvit Bank and 7.9% for Hana Bank)-NPL have shot up to 20.4%, way out of line with competitors [5.5% for Cho-Hung Bank and 0.7% for Summit Bankcorp (US)] (Ex. 8)

Relative Performance of Korean Industry Specific Stock Indices 120 100 80 60 40 20 0
Jun-96 Jun-97 Aug-96 Aug-97 Jun-98 Dec-95 Dec-96 Dec-97 Aug-98 Feb-96 Feb-97 Feb-98 Apr-96 Apr-97 Apr-98 Dec-98 Oct-96 Oct-97 Oct-98

Construction

Chemicals

Textile/Apparel

Transports

KFB Credit Risk (C)
Hanbo Steel: large exposure to a chaebol; loaning large amounts to a chaebol risky; “Connections with industrial groups increased the likelihood of distress for East Asian financial institutions during the East Asian crisis (Claessens, Bongini, and Ferri, JFSR 2001) Country rating decline during the Asian crisis by international agencies affected all Korean firms regardless of their individual performances (country-risk)

KFB’s Market Risk
KFB has reduced the % of corporate exposure to Korean market to 36.4% from 45.2% in ’96 (Ex. 9) However, their equity investments still high (and volatile) from 1268.4 in ’96 to 868.9 in ’97 to 1366.2 in ’98. As investment in foreign currency goes down over time, (from 802.9 to 683) there is slightly more vulnerability to Korean equity/bond markets Of course, compared to US banks (with no equity investment) KFB has higher risk.

KFB’s Interest Rate Risk (A)
In ’97, 4rth stage of interest rate liberalization by Korean government (Fig 4); significant negative impact on the bank: interest rates on deposit adjusting upwards instantaneously, whereas interest rates on loans take a while to adjust As a result of increasingly intensified competition among banks, interest on deposits increased causing downward pressure on average spreads KFB significant mismatch between loans and deposits (58.3% vs. 73.1%)- a lot different than Hana Bank (60.9% vs. 61.7%). Hana Bank the best performer in the group (Ex....
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