structure-profit relationship of commercial banks in South Korea and the United States: A comparative study, The

Multinational Business Review, Fall 1997 by Kim, Mihwa, Kim, Il-woon

The main purpose of this paper is to conduct a comparative study on the structure-profit relationship of commercial banks in Korea and the U.S. It has been found that, despite the government's efforts toward the liberalization and internationalization of the Korean banking industry during the last decade, the banks in Korea lag far behind the U.S. banks in terms of efficiency and profitability. The results also demonstrate that the capitalization rate, reserves for loan losses, and the size of the bank are important factors affecting the profitability of the bank in both countries.

INTRODUCTION

South Korea is well known for its miraculous economic growth during the last three decades. From a position near the bottom of the international income scale in the late 60s, Korea launched a bold series of economic development programs, which in two decades have transformed the country from a marginally subsistent agricultural economy into one of Asia's major industrial nations. During the process of such an impressive economic development which was planned and implemented by the government, Korean commercial banks played a critical role in accelerating the economic growth of the country. Until the late 1980s, the major commercial banks were owned and strictly controlled by the government in an attempt to boost the economic growth of the country. Both loan and administrative decisions were basically dictated by the government. Banks were encouraged to channel subsidized credit in the form of policy loans to the sectors of the economy that were being promoted, such as electronics, automobiles, steel, and defense products. Domestic banks were also tightly protected by the government against foreign banks.

The environment of the Korean banking industry, however, has been changed significantly during the last decade. Since the early 1980s, the government has pursued a financial deregulation policy in the hope of both raising the efficiency of the financial industry and coping with the on-going internalization of the domestic financial markets. The deregulatory steps included: 1 ) promotion of the autonomous management of banks, 2) introduction of interest rate liberalization, and 3) the extension of the business boundaries of financial institutions. In line with deregulation, market entry barriers have been reduced. The most significant effect of all these changes is an increase in competition among commercial banks in Korea.

The purposes of this paper are to conduct a comparative study on the performance of the commercial banks in Korea and the U. S. during the period of 1991-93 and to investigate their structure-profit relationships during the same period. The period was selected because of the many government restrictions in place until the late 80s, which would make it difficult to compare Korean banks with U.S. banks before. U.S. banks will be used as a control group, considering the fact that the U.S. banking system is one of the most sophisticated and advanced systems in the world. This study will give information on how efficiently Korean commercial banks operate compared to the U.S. banks after the liberation and internalization of the banking industry in Korea went into effect. This study will also reveal the structural factors affecting the performance of commercial banks in Korea and the U.S. This information will be valuable to investors who are interested in the banking industry of Korea.

LITERATURE REVIEW

There are many variables that affect the financial performance of commercial banks, such as regulation, ownership structure, interest rates, economic activity, technology, management quality, and cost efficiency. In general, however, the banking industry, like most other industries, relies heavily on accounting data as the main source of information for performance evaluation. This section discusses selected studies on bank performance, their performance measures, explanatory variables, and the time periods studied. Rose (1992) used several explanatory variables to examine the differences between the preacquisition and postacquisition operating performance of 279 interstate banking firms in the U.S. during 1980 to 1989. He used return on assets and return on equity as performance measures. The explanatory variables used were net interest margin, total revenue per employee, operating expenses divided by operating revenues, capital-to-assetratio, dividend-payout-ratio, average annual growth in deposits, noninterest expenses per employee, consumer-loan-to-total-loan-ratio, and loan-losses-to-capital-ratio. His study found evidence that acquisition by an interstate banking firm selectively benefited banks and consolidated banking companies acquired across state lines. Samolyk (1994) tried to identify variability in performance that might be attributable to differences in bank size, holding company affiliation, lending, capitalization, profitability, and asset quality. He regressed these six dependent variables on several explanatory variables, such as state, year, economic controls (including personal income growth, lagged personal income growth, failed business liabilities, lagged failed business liabilities), bank assets to personal income, holding company affiliation, and size. He concluded that the average differences in bank performance might be attributable to differences in bank size, holding company relationships, capitalization, lending, profitability, and asset quality.