Changes in Financial Environment and the Stability of Korean Banks(EP Vol.11 No.1)

Author: Jong-Ku Kang

These days, changes in the financial environment tend to increase the
possibility of a financial crisis. This paper analyzes factors affecting
individual banks' asset soundness, profitability, capital adequacy and
liquidity in Korea, using Korean banks' annual panel data from 1999 to
2004. Korean banks' financial data show that herd behavior among Korean
banks may have increased. It would thus be desirable for the policy authority
to keep a more careful watch over banks' behavior. The results of SUR
estimations show bank stability to have been negatively affected by increases
in asset size and in the proportion of retail business conducted, but positively
affected by business diversification, governance transparency and greater
length of maturity of deposits. The effects on banks' stability of an increase
in the overnight call rate seem ambiguous, as it has a negative impact on
bank profitability, a positive impact on bank liquidity, and no significant
effects on either the capital adequacy or asset soundness of banks. The
estimation results also imply that as a bank becomes larger in asset size, less
transparent in governance structure, and less diversified in its business lines,
its stability tends to deteriorate more severely when the overnight call rate
rises.