Tuesday, December 30, 2003

LG Card: a nice moral hazard case....

The trouble with LG Card in Korea continues, according to the FD. An additional 2.7 billion dollars should make the company ready for sale, but observers have some doubts.

The case of LG Card (see also previous entries on this blog) is interesting now that speculations arise as to the intervention of Korean government (or the Korean central bank). It is a fine example of a possible moral hazard. Moral hazard occurs when organisations or individuals act upon the assumption that government or central banks may bail them out in case of trouble. It distorts the regular process of taking and assessing risks and may result in financial losses (to be borne by the tax-payer).

With the LG Card, the situation was that the government promoted and supported the use of the credit-card. So all issuing companies did not care for risk management and shifted the Korean society from cash to credit-card oriented. As a result, each Korean individual now has 4 credit-cards and the outstanding credit-card debt amounts to 14 % of Gross National Product.

So the big question is now how the credit-card industry in South-Korea will be restructured. If government is to bail the industry out, it creates a precedent in which other organisations or industries may also start taking risks with the idea that government will help them. So it appears unlikely that this will happen. But then again, it will be hard to find buyers for the South Korean credit-card issuers...

Or would the IMF be willing to intervene.... ? This article on their website suggest that IMF financing has not proved to induce moral hazard.