South Korea shuts down ailing banks

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SOUTH KOREA closed one-fifth of its banks yesterday and prepared to transfer their business to stronger rivals, trying to limit disruption to its financial system at the risk of alienating foreign investors.

Five of 26 banks were shut - Daedong, Dongnam, Donghwa, Kyungki and Chung Chong. Together they account for 7.3 per cent of all Korean bank loans. Seven larger banks, including Hanil and Cho Hung, were given a month to shape up or face a similar fate. The clean-up cost for a banking system throttled by bad loans could reach $107bn (pounds 64bn).

"The myth that Korean banks never die is over,'' said Jason Yu, a banking analyst at Indosuez WI Carr Securities in Seoul. "Complete closure would have been better. This solution is a form of disguised support.''

The government has earmarked 17.5 trillion won to buy bad loans, aiming to cushion the impact on acquirer banks and prevent a run on deposits that could destabilise the economy.

The shotgun mergers drew criticism from foreign investors, who are not convinced that the finances of the acquirer banks won't deteriorate.

"Forcing good banks to merge with weak ones reduces the health of the Korean banking system to its lowest common denominator,'' said Tim Julien, portfolio manager at Mercantile Mutual Investment Management in Sydney.

Bank reform is the centrepiece of Korea's efforts to shake off its first recession in 18 years.