Tuesday, November 25, 2003

Korea's LG Card: case of the monetary relevance of the creditcard

These days, most newspapers report about the Korean company LG Card, with 14 million customers one of the biggest issuers of credit cards in Korea, that is in severe trouble. This is an interesting demonstration of the monetary relevance of payment instruments. Let's see what has happened...:

The Korean government wanted to eliminate the grey market in the retail sector and wanted to give a boost to consumer spending as well. So it decided to stimulate te use of the credit-card by fiscal measures. This worked fine: the economy grew 6,3 % in 2002.

The downside however, was that Korean customer did not really have the money. So as the customers faced problems in paying back the credit-card company, LG Card started getting into trouble with an outstanding sum of more than one billion millions dollars. In order to save its daughter company, the Korean Exchange Bank last week notified the public that it would take over LG Card. And it went on to restructure the debt.

The restructuring of the debt took a while, so last friday, credit-card users could not get any money from the ATM. The operators had shut down the usage due the debt position of LG Card.

Yesterday it was announced that -again under strong pressure of Korean government- Woori Finance en seven other banks provide a loan to LG Card of 2000 billion won (which is 1,4 billion euro), to be paid back within the year.

Given that the loan is not backed by securities or assets (so actually it was really forced upon the banks), the stock market reacted. The Korean banks saw their share prices falling with 2,5 to 5 % taking along the South Korean Stock Market Index. And with it the the currency exchange rate for the Won.

One of the primary lessons we can draw from this case, is that money is not only a means of exchange, but also a store of value. What we see in this example is that the government uses the monetary functions of payment instruments as means of monetary policy. Formally, monetary policy is of course the remit of central banks, but the Korean government has indeed found an interesting way of bypassing central bankers.

We can rest assured that this case will be studied in more detail by central bankers all over the world. Their conclusion will be: leave monetary policy to the central bank and be careful not to jeopardize the financial sector of a country for the cause of short term-politics.