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A regulatory nerd picks apart a Hankyoreh article

An interesting article (at least for that tiny population of amateur Koryologists whose day job involves bank regulatory capital ratios) in the Hankyoreh about Kookmin’s acquisition of Korea Exchange Bank. As usual though, one gets frustrated reading stories written by people who don’t have a clue what they’re talking about and which are not properly checked by someone who does.

Though I’m not an expert in Korean capital regulation (Yes, I’m frustrated with myself), it seems from the article that there are restrictions on the amount of capital a bank can invest in an affiliated bank or banks. And that limit is 30% of the investing bank’s capital.

But the author spoils it all with a confusion which he seems to share with the politician who, judging by his line of argument, either wants to torpedo the deal or knock down the price (thus reducing Loan Star’s profits). You don’t need to be an expert in Korean financial regulation to know that “capital” is not the same as “capital ratio”. You just have to understand the meaning of the words you’re using.

Here’s the Hakyoreh article, together with the comments I would have made if I were the Hankyoreh’s financial editor.

Civic group cries foul in bank deal
Debate comes amid review process for acquisition of Korea First Bank

Controversy is erupting on the matter of when a bank’s equity capital ratio should be measured [if there is, it’s irrelevant to this article]. The ratio [er, no. You say below it’s the amount of capital. “A” is completely different from “A over B”, dummy, particularly when B is a daily changing variable around ten times as big as A] determines how much money a bank is allowed to invest in subsidiaries, and would play a big part in Kookmin’s ability to acquire Korea Exchange Bank.

The debate comes amid the review process for Kookmin Bank to acquire Korea Exchange Bank from its major shareholder, U.S.-based fund Lone Star. Experts criticized the financial regulators for making a rough estimate on figures in the middle of negotiations over a deal potentially worth 7 trillion won (US$7 billion).

The Financial Supervisory Service is arguing that the measurement of a bank’s equity capital ratio should be performed on the date a bank decides to acquire a company, whereas Kookmin Bank says the ratio should be measured from the date when a bank buys its initial stake in the company to begin the acquisition process. Currently, finance firms are barred from investing more than 30 percent of their total capital in subsidiaries. [see: capital, not capital ratio]

According to a regulatory filing by Kookmin Bank on October 2, the bank’s equity capital was 15.68 trillion won as of the end of 2005, which would allow the bank to invest 4.7 trillion won in its affiliates. [careful. Do you mean “equity capital” or “total capital”? They are different. Total capital includes subordinated debt and other stuff: you mention below that Kookmin’s investment capacity was boosted by a debt issue] But because Kookmin Bank has already invested a total of 385.4 billion won in its 11 affiliates, the bank would be allowed 4.3 trillion won to invest in sealing the deal it has inked with Lone Star.

The figure of 4.3 trillion won has also been called into question, as Kookmin agreed to purchase stakes of Korea Exchange Bank for 15,200 won per share, which would mean a 70.87 percent stake would cost 6.9 trillion won in total. With shares at the agreed-upon price, for Kookmin to buy even a 50-percent stake – the amount required to become a major shareholder – the bank would need to invest 4.9 trillion won, 582.1 billion won more than the currently agreed sale price [I think you mean “investment limit” (4.3 trillion), not “sale price”. Otherwise you’re saying that “a 50% stake, at the agreed sale price, is more than the agreed sale price.” Which is clearly tosh.]

Rep. Sim Sang Jeong of the minority Democratic Labor Party has raised the matter, saying that the date of setting a bank’s equity capital ratio should be counted from the end of the fiscal year a bank acquires a stake in a company, citing the terminology “recent fiscal year” in official banking regulations. [er, do you mean “end of the fiscal year a bank acquires a stake” — ie you buy the stake, and then hope that by the end of the year you’ve got enough capital so you haven’t breached the investment limit? Or do you mean “end of the financial year immediately preceding the acquisition” — which makes more intuitive sense and ties in with your calculations?].

“In that case, it is legally impossible for Kookmin Bank to acquire more than a 50-percent stake in Korea Exchange Bank,” the lawmaker said.

What is fueling the controversy is that there is no clear definition of how to determine a date for measuring a bank’s equity capital ratio when the bank invests in a unit. [Again, capital, not capital ratio] A Financial Supervisory Service official said, “Because there are no clear terms set forth, we will have to make the decision on our own. The date may be counted from a date when Kookmin Bank approved the acquisition of Korea Exchange Bank.” In which case Kookmin Bank would meet the investment ceiling in acquiring Korea First. [Ambiguous word. “meet” could mean “comply with”, in which case there’s no disagreement between the FSS and Kookmin. I assume you mean “breach” the investment ceiling] In March, Kookmin Bank had already raised 1.9 trillion won through the sale of bonds. During the first half of this year, Kookmin Bank additionally boosted its equity capital by more than 3 trillion won via business returns.

Kookmin Bank says that the investment ceiling should be counted from a date when it purchased the Korea Exchange Bank stake. In this case, Kookmin Bank may successfully acquire the 70.87 percent stake in Korea Exchage Bank. [Things still don’t add up. In order to invest that much (6.9 trillion), taking into account their other investments of 385.4 billion, they would need capital of over 24 trillion. If at the end of 2005 they had 15.68 trillion, and had subsequently raised 1.6 trillion externally and generated profits of more than 3 trillion they have capital of only around 21 trillion]

Hongik University economics professor Jeon Seong-in said, “The problem is that financial regulators failed to set a date for calculating a bank’s equity capital ratio in the first place,” and now they will merely make the decision retroactively and of their own accord, he said.

[Now I’ve finished the article, your headline says “Civic Group Cries Foul”. You haven’t mentioned any civic group crying foul. Altogether a sloppy piece of work. You’re fired]

All this hot air about which date to chose is clearly in part politically-driven. But in any other market there’s an easy answer. If a bank wants to take advantage of capital which has been generated (whether by interim profits or by share issues) since the most recently filed audited annual financial statements, they get in the auditors to verify the capital issued / review the profits. Once it’s audited, the bank should be allowed to take advantage of it. And if you don’t have the necessary capital (and hence investment capacity) at the time of signing the deal, you need to make completion conditional upon raising that extra capital.

So, for Kookmin: not that I’m asking for a job, but don’t you think you need a reg guy on board to keep you on the straight and narrow? That way you might not end up in the embarrassing position of maybe not being able to complete on a deal you’ve set your heart on.

And, dear reader, I know I’ve just bored you senseless, but this post was just for me.

2 thoughts on “A regulatory nerd picks apart a Hankyoreh article

  1. Philip I made it to nearly half way and then couldn’t go any further though still enough to satisfy myself that you had the author on the ropes. I had forgotten just how dry reg matters can be!

    Can you suggest a full reading by our good friend Mr Tucker as a test of his concentration.

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