[Editorial] Reforming lending practices

More than 30 years ago, Kim Seok-dong, chairman of the Financial Supervisory Commission, tasted the bitterness of business failure. In 1978, he started a leather jumper exporting business after working for a trading company for a year.

Kim’s company ran into trouble when the second oil shock hit the nation in 1979. As business soured, he faced funding problems. To keep his company afloat, he went to his bank to get trade financing.

But the bank demanded that all his family members, including even his parents-in-law, stand joint surety for a loan. He found the demand excessive and could not accept it.

So he gave up efforts to get a bank loan and had no choice but to let his fledgling enterprise go belly up.

The bitter feelings Kim had at the time are still vivid in his memory. And they underlay his recent decision to abolish the noxious, time-old lending practice, which he rightly viewed as a drag on the government’s efforts to stimulate youth start-ups.

Kim pledged to reform the deeply entrenched joint surety system by March, describing it as an arrangement that “destroys not just the failed entrepreneur but his entire family and relatives.”

The financial regulator’s decision is more than welcome. Reform of the outdated lending practice is long overdue. The harmful arrangement has not only discouraged entrepreneurship but impeded the development of the domestic financial industry and the nation’s economic growth.

Financial institutions are all well aware that their practice of requiring an entrepreneur to get joint guarantors for a loan puts a damper on the entrepreneurial spirit in Korea.

But they have been reluctant to give up the convenience of transferring all the risks involved in lending to borrowers. Under the collective surety system, lenders can collect a loan from joint guarantors when a borrower defaults on it.

But this is a facile way to manage risks. By relying on it, financial institutions have avoided the difficult task of developing sophisticated risk management skills. As a result, they retarded the development of the financial industry.

Banks and state-run credit guarantee companies should be able to extend loans or credit guarantees to entrepreneurs based on an objective assessment of their creditworthiness, their business prospects or the value of their technology or intangible assets.

But this capability cannot be acquired overnight. Financial institutions need to invest to cultivate expertise in this area. This means if the regulator abolishes the current lending practice all of sudden, it could cause problems.

A recent survey conducted by the FSC showed that financial companies are not prepared for a reform in their lending practice. According to the survey, 61 percent of loan officers at banks and credit guarantee companies said they had difficulty assessing the business prospects of small and medium-sized enterprises and venture companies.

About 40 percent complained about the lack of information in assessing the creditworthiness of entrepreneurs, while 21 percent said they could not appraise the information related to the technological capabilities of start-ups or SMEs.

Before reforming the joint surety system, these problems need to be addressed. Otherwise, financial institutions could reduce lending to start-ups and SMEs due to increased risks.