More Exchange Bank Takeover Suspicions

Suspicions are rising that the Banking for International Settlements capital ratio of the Korea Exchange Bank (KEB), known as the BIS ratio, was manipulated in the run up to the sale of the bank in 2003 when the nation’s auditing agency and the prosecution launched investigations in earnest.

The BIS capital ratio is a critical measurement that grades the soundness of banks. Banks are regarded as healthy when the ratio exceeds eight percent.

At issue is a report released by the Financial Supervisory Commission (FSC). The commission, which had predicted the BIS capital adequacy ratio of the KEB to be over eight percent in early June 2003, changed its opinion and predicted the ratio would fall below the eight percent level in July.

The FSC concluded based on the July report that Lone Star should get approval to buy KEB because the bank was likely to have financial troubles ahead.

Under Korean banking law, foreign investors who are not financial companies can own only a 10 percent stake in domestic banks. Exceptions can be made only when special cases, such as clearing off insolvent financial services, are involved.

How the Financial Supervisory Service (FSS) report was made-

On July 15, 2003, an emergency meeting at the KEB was held with officials from the Ministry of Finance and Economy, the Financial Supervisory Commission (FSC), KEB, Morgan Stanley (KEB’s advisory firm) present.

Lee Kang-won, then KEB head, said “Without one trillion won of Lone Star’s investment, the bank’s BIS capital ratio might fall to 5.4 percent and we want the government to eliminate obstacles that block the U.S.-based private equity firm’s investment in KEB.”

The FSC with the authority to assess the qualification for largest shareholder requested the FSS on July 16 to submit the report about KEB’s BIS capital ratio.

The FSC maintained that it concluded the report that BIS capital ratio of KEB at the end of the year is likely to fall to 6.2 percent on July 25, based on five faxes that a KEB deputy general manager sent on July 21.

These faxes determined the fate of KEB but they did not have signs of KEB president and executives.

Eom Ho-sung, representative of the Grand National Party said “There are huge difference between the document saved in the computer of the deputy general manager who passed away last August and the document that the FSS received.” He raised doubts over the authenticity of the FSS document, saying it might have been written outside of KEB.

Flaws in the Report-

The FSS’s BIS capital ratio report has many suspicious points.

The report predicted that Hynix Semiconductor Inc.’s stock price might fall to 1,000 won a share, causing an additional 100 billion won in loss at the end of the year. At the end of June, the stock price of Hynix was 5,790 won, and critics say the report was overblown.

Even the official at KEB reported in the directors’ meeting on July 21 that “accounting firms and the state auditing agency are in consensus that Hynix will see 145 billion to 192 billion won in extraordinary gains from stock price increases.”

The FSS predicted that KEB will see 343.8 billion won in additional loss by the end of 2003 when the bad loan rate of 1.09 percent for four years. This estimation is possible, if situation is very pessimistic, but is not commonly used.

Therefore, the July 25 FSS report deserves suspicions that it is half-baked.

Who Estimated KEB’s Insolvent Asset-

The essence of BIS capital requirement is the size of insolvent asset.

At the directors’ meeting on July 28, Lee Dal-yong, then vice president of KEB said “Samil PricewaterhouseCoopers estimates 1.36 trillion won in loss on the basis of pessimistic scenario and Lone Star predicts 1.6 trillion in loss at the end of the year.”

Samil PWC and Samjong KPMG were in charge of the KEB takeover, commissioned by KEB and Lone Star, respectively.

Coincidentally or not, the FSS’s estimate of insolvent asset was 1.68 trillion won, close to that of Lone Star. If the FSS simply accepted the scenario of Lone Star who was bidding for the takeover, the commission will not be able to avoid criticism.

Critics raise questions that KEB lowered its BIS ratio to 6.2 percent according to the report of Samjong KMPG on insolvent asset. Yet KEB and Lone Star deny the suspicion.