Sweet Deathtrap - Currency Mismatch..

So, how exactly do 'Foreign Bankers' behave differently from domestic Korean banks? Why are their lending activities mainly short-term? Is it because they view the Korean market as unsafe and therefore do not commit in the long-term? Probably, as Cho and Kalinoswi (2010) commented, are they more likely to be risk adverse and biased regarding corporate lending? 

Such questions are extensively examined in the study conducted by Jeon et al. (2006). Considering the opposing view points with respect to the influence of foreign bank entry on developing financial markets, Jeon et al.(2010) analysed Korean banking sectors to find whether the degree of stability has been improved and the market volatility has been reduced by the induction of foreign banks. Their findings suggest that the lending practice by foreign banks tends to be more opportunistic; thus, follows portfolio theory. Such observations of foreign banks behaviours indicated plausible evidence that foreign banks poured massive foreign currency loans into the Korean market before the crisis (i.e. as long as the macro-economic conditions appear to be attractive for them); therefore, the rapid capital reversals at the on set of the global crises triggered mainly by those foreign banks (Jeon et al., 2010).  

Another overlooked danger in exposing domestic banking sector to foreign bankers would be the hidden trap of 'currency mismatch' which deepen the financial crises, especially when domestic banking systems were yet to be fully grown to protect itself from the sudden external shock.  

During the last Thursday lecture,  I briefly learned what is meant by 'currency mismatch' and its negative consequences in many Asian emerging markets, I researched this topic intensively.  After read through the report about the problems with currency mismatch written by Morris Goldstein and Philips Turner, in their book (to access click 'HERE'), I gained some background knowledge while analysing the graph below shown in the research by Yoon et al (2009).  

According to Yoon (2011) and Goldstein and Philips (2004), currency mismatch occurs mainly due to high volatility in foreign exchange markets and refers an increasing discrepancy in currency value between foreign assets and foreign liabilities, thus indicates the foreign liquidity trap. Especially, many emerging markets, where external debts are made mostly under the short-term base and denoted by foreign currency, are much more susceptible to abrupt movement of foreign capital and currency fluctuation as exemplified by the case of the Korea crises. 

In short, it seems that the more the domestic market is liberalized, the more unstable the financial market becomes. As long as a domestic economy is on its way to constructing solid market fundamentals with proper regulations before foreign investors coming to play, such expected externality from sudden liberalization forced by outsiders would be inevitable. 

Would it be fair to say that the culprit behind the short-term currency mismatch was the 'Banking Sector', and behind that banking sector, there were foreign branches of banks in Korea? I am inclined to say "Yes" to this question. 

Source: Yoon et al.(2009, pa 154) - graph above also presented in his article in 2011, page 118.

Data source: Bank of Korea http://ecos.bok.or.kr 

Cho, H., and Kalinowski, T. (2010), Bank Nationalization, Restructuring and Reprivatization: The Case of Korea since the Asian Financial Crisis, Korea Observer, 41(1), 1-30.

Goldstein, M. and Turner, P. (2004), Controlling Currency Mismatches in Emerging Markets, The Peterson Institute for International Economics, available at http://bookstore.piie.com/book-store/373.html, Accessed 23rd Feb. 2012. 

Jeon, Y., Miller, S. and Natke, P. (2006), 'Do Foreign Bank Operations Provides a Stabilizing influence in Korea?', The Quaterly Review of Economics and Finance, 46, 82-109.

Yoon, D.  (2011) 'The Korean Economic Adjustment to the World Financial Crisis', Asian Economic Papers, 10(1), pp. 106-126.