Chaebols owning banks: should we be concerned?

One of the ideas to surface in the run-up to the Korean elections was that chaebols should once more be permitted to invest in banks. The proposed revision in policy prompted KBS to try to do a brief survey of practices in various markets in relation to rules regarding ownership of banks by non-bank companies. Copy deadlines back in Seoul prevented any really serious research in the UK, but here are the pointers I would have provided.

As readers will be aware, the concern that some people raise when faced with the proposal is that the chaebols will use the banks as their personal “piggy-banks” – that is, the chaebols will use the banks they might own as a cheap source of funding and capital. This could potentially weaken the competitiveness of such banks and potentially threaten the interests of the banks’ depositors.

That does not have to be the case.

In the UK, I can think of no restrictions on who can own a bank. Many retail companies – Tesco, Sainsbury, Harrods, Marks and Spencers for example – own banks or financial services companies to sell additional products to their customers, where they perceive that their customers have strong brand loyalty.

Those are examples of banks which complement the strategy of the larger retail organisation to which they belong. As an example of a less obviously complementary grouping, in the more distant past I can recall that there was a UK bank which was part of a group which owned tea plantations and confectionery factories. While some observers might put a chaebol bank in the latter category, there are clearly some chaebols which have a strong brand recognition, where additional business could potentially be generated for the bank by joining the larger group (though of course this depends on whether the bank has a strong independent brand of its own).

But whether the investment is made because the bank is a good strategic fit or simply because the investor sees the opportunity of a good return on equity, how can one stop the investor “looting” his new toy?

First, before someone can buy or become a significant investor in a bank, they need the approval of the local regulator – as HSBC are finding in relation to their proposed purchase of KEB.

The key control exercised by the UK regulators in determining the whether a company or an individual could own a bank used to be the “fit and proper” test1. Ultimately, the regulators are concerned with the protection of depositors and the safety of the financial system. In approving the “controller” of a bank (which included both senior management and owners) the regulators consider experience and competence, and also look closely at the business plan supporting any change in ownership or control. If there’s no sensible business case, the acquisition doesn’t get approved.

While this regulatory control is relatively powerful, it is far from objective. Once an owner is approved, much more objective and easily monitored tools are in place to ensure an owner does not use the bank as their own private piggy-bank.

First and foremost come restrictions on intragroup lending. Regulators don’t like seeing banks’ assets being concentrated in one particular area, or seeing a bank’s ongoing success being dependent on one of its customers not defaulting. For this reason there are restrictions on the amount of lending you can do to any one customer (or group of connected customers). And those restrictions include lending to your affiliates. For these purposes, EU regulators treat your affiliates as if they were arm’s-length customers. So, caps on intragroup lending is one tool. That puts a limit on the amount of cheap funding a chaebol would be able to get from an in-house bank.

Second, restrictions on intragroup capital investments. Regulators permit a certain amount of equity investments by banks in unconnected companies before they start getting nervous. They may even permit a certain amount of equity investment in affiliates. But the strictest regulators demand a dollar deduction from a bank’s capital for every dollar the bank invests in the equity of one of its affiliates. That pretty much kills the sort of cross shareholdings prevalent in the chaebol world insofar as they might include a new bank affiliate.

Finally, regulators have in the past tried to stop gaming of these rules by saying that “connected lending of a capital nature” should be deducted from a bank’s capital base. This type of activity is perhaps more difficult to identify and define, but the threat of having such lending classified in such a way could often be sufficient for the bank to take appropriate action to allay the regulator’s concerns.

Will all those controls prevent a bank being looted by its owner? No system is totally fool-proof. No amount of regulatory rules can stop concerted criminal activity – but that applies regardless of who owns the bank. In short, with a reasonable set of regulations, adequately monitored, there doesn’t seem to be a compelling case for prohibiting the ownership of a bank by a deep-pocketed Chaebol.

  1. I’ve not had time to research the latest terminology for this article []

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