[Desk Column] The Boundary Between Banks' 'Greed' and Financial Authorities' 'Dereliction of Duty'

[Asia Economy Reporter Lee Cho-hee, Head of Finance Department] On April 15, 2014, Choi Soo-hyun, then Governor of the Financial Supervisory Service (FSS), gathered the heads of 10 major commercial banks in one place. At that time, South Korea's financial system was in a state of 'total insolvency,' with widespread issues such as improper loans, illegal account inquiries, slush fund suspicions, and customer information leaks occurring across banks, insurance companies, credit card companies, and savings banks.

Governor Choi publicly warned, "Financial companies and management that have lost the trust of the people can be shunned by customers and face stern market judgment leading to their exit." While meetings among bank heads were occasionally held, it was unprecedented for the FSS Governor to summon major bank CEOs directly to the FSS and publicly reprimand them. A few months later, hundreds of employees from financial companies related to these issues received mass disciplinary actions at the FSS Sanctions Review Committee (Sanctions Review), marking the largest scale in history. Some financial leaders had to step down from their positions.

Financial companies deserve criticism and accountability for betraying customer trust and pursuing their own interests through improper means. However, this was not solely the problem of financial companies. Governor Choi’s public warning at the time was tantamount to admitting that the supervisory authorities had failed in their management. That year, the Board of Audit and Inspection demanded disciplinary action against relevant employees, citing negligence and poor management and supervision by financial authorities as major causes of some incidents.

On January 16, 2020, the FSS Sanctions Review was held for bank CEOs for the first time in five years, related to the overseas interest rate-linked derivative-linked fund (DLF) scandal that caused massive principal losses. The DLF incident shocked the market because banks, which had emphasized that customer trust was their most important asset, concealed the high-risk nature and engaged in incomplete sales. Some bank CEOs involved in selling DLFs were pre-notified of severe sanctions, including a three-year ban on employment in financial companies. The financial authorities cited excessive sales efforts at the bank headquarters level and poor internal controls as grounds for disciplining management for the incomplete sales of DLFs.

The FSS’s judgment has merit. According to the supervisory authorities, banks sold products with similar underlying assets as private placements to evade public offering regulations, resulting in inadequate investor protection mechanisms. Investor protection was also weak during the sale of high-risk products. Financial accidents are common in the financial industry. This is why powerful supervisory agencies exist in finance. It may be because finance is both a money-handling business and a regulated industry.

In 2015, as part of a policy to revitalize private funds, the Financial Services Commission lowered the investment requirement from 500 million won to 100 million won. This is not to blame deregulation. In a way, the core business of banks is 'money trading.' Domestic banks have conducted money trading within the framework permitted by the government and continue to operate in that business. Of course, they must abandon greed and conduct safe money-making based on trust. Having experienced the risks of derivative financial products through foreign investment banks after the financial crisis, more conservative management and supervision were necessary when banks, trusted by financial consumers, sold such products.

DLF is a 'high-risk low-return' product that deviates from the basic principle of 'high-risk high-return.' Even when banks sold about 60% and securities firms about 20% of these high-risk derivatives, the authorities remained passive. If a product sold under a thorough supervisory system was deemed 'incomplete sales,' can the FSS, which failed to supervise it, be free from legal responsibility?

It is the duty of supervisory agencies to investigate and impose sanctions when problems arise. However, some criticize that excessive sanctions are imposed on bank CEOs based on grounds not stipulated in regulations, unfairly shifting responsibility solely onto them.

Major financial accidents such as the credit card scandal and the global foreign exchange crisis generally had warning signs. It must be acknowledged that financial authorities failed to respond proactively and examine matters carefully, allowing the issues to escalate. It will be interesting to see in what form the financial authorities will take responsibility to prevent recurrence of such incidents.