[Seungseop Song's Financial Light] Why Are Mutual Finance Regulations Becoming Stricter?

Improving Cooperative Members' Economic Status and Providing Convenience Are the Essence of Mutual Finance
Loose Regulations Cause 'Moral Hazard'... LH Scandal as a Decisive Blow
Strict Screening of Farmland Mortgage Loans, 'Self-Loans' Also Restricted

Finance is difficult. It is filled with confusing terms and complex backstories. Sometimes, you need to learn dozens of concepts just to understand a single word. Yet, finance is important. To understand the philosophy of fund management and consistently follow the flow of money, a foundation of financial knowledge is essential. Accordingly, Asia Economy selects one financial term each week and explains it in very simple language. Even those who know nothing about finance can immediately understand these 'light' stories, lighting a bright 'fire' of financial insight.

[Asia Economy Reporter Song Seung-seop] Financial authorities have announced regulatory measures for the mutual finance sector. Loan procedures have been strengthened, and regulations on executives and employees have been introduced. Among many financial sectors, why was only the ‘mutual finance’ industry singled out for regulation?

Mutual finance refers to financial institutions that collect deposits from members and lend money to other members. The difference from commercial banks is that they collect money from an unspecified majority of customers and lend to an unspecified majority. Another difference is that mutual finance does not pursue profit but aims to improve the economic status of other members and provide financial convenience. If people who want to form a cooperative gather money and lend it within the members, that is mutual finance.

Unit cooperatives scattered across each region receive deposits to cover loan funds and operating funds. The remaining money is entrusted to the ‘Central Association.’ The Central Association pools this money and invests it in bonds, real estate, stocks, etc., and pays a certain amount of interest back to the unit cooperatives. The unit cooperatives then return this money to the members who made the deposits in the form of dividends.

Mutual financial institutions first appeared in the 1960s and 1970s. Currently, there are Agricultural Cooperatives, Fisheries Cooperatives, Forestry Cooperatives, Credit Cooperatives, and Saemaeul Geumgo. These institutions were a great help to farmers, fishermen, and small business owners who found it difficult to borrow money from large banks. Especially for members, mutual finance was a very useful financial institution because they could borrow money without large collateral or joint guarantors.

‘Moral Hazard’ Created by Loose Regulations... Financial Authorities Draw the Sword

The problem was that relatively loose regulations often led to ‘moral hazard’ issues. Agricultural Cooperative A in the Gyeongnam region violated the regulation that prohibits lending a certain amount or more to the same individual and was sanctioned with suspension of duties by the Financial Supervisory Service. Credit Cooperative B in Jeonnam was caught handling eight loans secured by neighborhood shops and land by four employees violating regulations. There were also cases where massive ‘dividend feasts’ were held despite deteriorating soundness and performance.

[Image source=Yonhap News]

Recently, controversy erupted when it was revealed that employees of Korea Land and Housing Corporation (LH), who were not members, received large loans from nearby unit agricultural cooperatives in the 3rd New Town area for speculative purposes. Most of the land purchased by LH employees was rice paddies and fields, and it became problematic that they received ‘agricultural land secured loans’ even though, under the Agricultural Land Act, only farmers can receive such loans. Some agricultural cooperative employees also caused controversy by taking out loans under family members’ names to buy farmland and make capital gains. The cause was attributed to loose loan screening in the mutual finance sector and a loan-to-value ratio (LTV) of up to 70%, higher than the average 60% of commercial banks.

In response, financial authorities have taken decisive action. On the 25th, the Financial Services Commission held the ‘2021 1st Mutual Finance Policy Council’ to discuss institutional improvement plans for the mutual finance sector. Going forward, if individual business owners receive agricultural land secured loans, these will be considered business funds, and the screening process will become more stringent. If the Agricultural Land Act is violated and disposal measures are taken, the loan will be recalled mid-term. Internal control standards now include regulations preventing executives and employees from freely making ‘self-loans,’ with penalties for violations.

The government will gather opinions from related ministries and the mutual finance sector on these matters until the end of August. The actual legislative notice is scheduled for September.