[Shaking Financial Leadership]⑥ "If Mistaken, Fines Should Be Imposed to the Extent of Bankruptcy"

Interview_Hyo-seop Lee, Senior Research Fellow at the Korea Capital Market Institute./Photo by Hyunmin Kim kimhyun81@

[Interview = Jeong Jaehyung, Economic Finance Editor; Summary = Boo Aeri, Reporter] Every year, the financial sector continues to face controversies such as the Derivative Linked Fund (DLF) scandal and large-scale embezzlement cases. Some argue that improving external controls is an urgent priority to enhance the internal control systems of financial companies. They suggest that rather than personal sanctions like disciplining CEOs, stronger external controls involving astronomical fines or definite incentives are necessary.

Lee Hyoseop, Senior Research Fellow at the Korea Capital Market Institute, pointed out, "Foreign financial firms have strictly managed risk and consumer protection, but Korean financial companies are obsessed only with performance competition and bonuses, and they do not spend enough money or manpower on building internal control systems."

In fact, overseas countries such as the United States impose astronomical fines for unfair gains through poor sales of financial products and interest rate manipulation. In 2016, Wells Fargo Bank in the U.S. was fined $3 billion after it was discovered that over 2 million deposit and credit card accounts were opened without customer consent. Additionally, in 2013, U.S. judicial authorities imposed a punitive settlement of $13 billion on JP Morgan for its responsibility in causing the 2008 financial crisis through poor sales of mortgage-backed securities (MBS). When CEOs make mistakes and are fined astronomical penalties, the board naturally holds them accountable for management failure, dismisses the CEO and other executives, and appoints a new CEO.

On the other hand, in Korea, financial companies neglect internal controls due to minor fines and social factors. Culturally, when problems arise in financial companies, someone usually takes responsibility, steps down, and the issue is closed. Especially for the four major financial holding companies, since overseas investors hold dividend-related rights, from the financial companies’ perspective, replacing one CEO with another is the least costly method. Because this approach continues to be accepted, financial companies do not spend much on building internal control systems, and the compliance monitoring departments are not regarded as significant units.

For this reason, Lee argued that legal-based external controls need to be much stronger than they are now. He said, "A punitive fine system with a strong penalty is necessary when wrongdoing occurs." Under the current Financial Consumer Protection Act, financial companies can be fined up to 50% of the sales commission profits. For example, the total fines imposed on the four major domestic banks for the incomplete sales of Lime Funds amounted to only 14.5 billion KRW. The fines imposed on each bank are only in the tens of billions of KRW, which is very low compared to the consumer damage that can reach hundreds of billions to trillions of KRW. Lee pointed out, "Overseas, fines can be up to three times the amount of damages. It is reasonable to impose fines several times the amount of consumer damage."

He continued, "For internal controls to work well, sanctions must target the most vulnerable parts of financial companies," emphasizing, "The most frequent issues are unfair trading and incomplete sales, and companies should be fined to the extent that they could go bankrupt."

Lee also added that incentives need to be clearly established. He said, "If fines are imposed for illegal acts and incentive systems are used when internal controls are well maintained, companies will spend more on internal controls. From an economic perspective, there are many studies showing that clear penalties and incentives reduce moral hazard. Internal controls should be used to reduce fines when they are properly maintained."