ABSTRACT
The origins of Korea’s financial crisis predate 1997. Administrative guidance and statedirected lending, which had appeared to work in the early stages of industrial development, created an industrial structure characterised by highly leveraged firms and a banking sector with little experience in managing risk. Against this backdrop, in the early 1990s the government embarked on a program of financial liberalisation, without simultaneously strengthening prudential standards. Confident that the state would always bail them out, banks and companies piled up debt through imprudent and barely monitored lending. Under such circumstances Korea was always vulnerable to any internal or external shock that might alter the fragile balance. That catalyst emerged in 1995–6, when an adverse terms of trade shock affected firms’ ability to service their huge build-up of short-term debt commitments, triggering a series of corporate bankruptcies and banking defaults. If, as this chapter argues, the causes of the crisis were systemic, the appropriate policy response was not simply the provision of funds to accommodate shortterm liquidity constraints and the restructuring of debt. Rather, a commitment to fundamental structural and institutional reforms was necessary as a precondition for reviving access to international capital.
