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Commentary: South Korean credit crisis offers a lesson for China

By William Pesek Jr. Bloomberg News

MAY 19, 2005 - Everyone seems to have a jaw-dropping statistic to put China's boom into perspective. Many focus on the country's insatiable demand for commodities like oil and steel. Or the waves of foreign direct investment rushing to China. Or its rapidly increasing military spending. Now another industry may soon be overwhelmed by the China effect: credit cards.

After generations of adhering to the Confucian aversion to debt, China is warming up to plastic. While data is hard to come by, the chief executive of American Express, Kenneth Chenault, said in December that credit card penetration in China was about 3 percent, and poised to surge.

Considering the size and growing affluence of China's population, it is easy to see why American Express, Citigroup and HSBC Holdings are showing interest. But can China avoid South Korea's household-debt blunder?

"It's clearly a mistake China wants to avoid," says Ifzal Ali, chief economist at the Manila-based Asian Development Bank.

From the ashes of the Asian financial crisis, South Korea quickly emerged as a role model for the region. It rebounded by strengthening its financial system, reducing foreign debt and reining in the conglomerates that dominate the economy. It encouraged banks to stop lending to shaky businesses, which had been a cause of the crisis.

Yet efforts to restore proper risk management in its banking system backfired. When they halted lending to the corporate sector, bankers turned their sights on households. Individual loans mushroomed, as did the number of credit cards lining consumers' wallets.

The trend proved disastrous. Soaring household debt and default rates drove the economy into recession and led to billions of dollars worth of bailouts for credit companies.

Before the crisis, South Koreans had little experience managing debt, to say nothing of high-interest-rate credit card debt. The lack of sophisticated systems for checking creditworthiness complicated matters. Walking the streets of Seoul between 1999 and 2002, one confronted a barrage of hawkers handing out credit-card applications.

It hardly helped that the government was encouraging credit card use with tax benefits. That drove banks and nonbank lenders to step up marketing efforts.

Feeling guilty and realizing how big a problem it had on its hands, the South Korean government organized bailouts. That sent a terrible message to markets. Credit card issuers extended credit to just about anyone who wanted it, and were left with surging delinquencies as the economy slowed and households couldn't service the debt.

Credit card companies over-leveraged to an extent that investors and regulators did not realize. Many of the loans were securitized through asset-backed securities. Most of the debt was short-term and had to be rolled over, meaning that the assets were not fully taken off balance sheets. And then, the government saved these gamblers.

Only now is South Korea shaking off the effects of these blunders. At last, its economy is growing again and households are confident enough to increase spending. While Chinese demand for Korean goods is certainly a factor, so are improved consumer finances.

China must be careful to avoid a Korea-like debt meltdown. With the benefit of hindsight, China may indeed do that. Besides, there is no guarantee that Chinese will take to plastic as, say, Americans have. The increasingly affluent middle class may, but will hundreds of millions of Chinese warm up to high-interest-rate debt?

Understandably, such risks aren't deterring credit card companies. The Chinese already rank among the world's most influential shoppers, buying more cellphones and televisions each year than U.S. consumers do. Yet Chinese demand is a small fraction of what it might be in 10 years.

Think what it would mean for issuers if even 20 percent of Chinese put two revolving credit cards in their wallet. And think of the consumption multiplier-effect that debt can produce. Debt, managed responsibly, has the potential to add momentum to Chinese consumption trends.

Serious consumer education, however, is needed. MasterCard International, for example, is working with banks, the media and universities to inform Chinese about the intricacies of debt management. China's government also has a big role to play.

Such concerns may be overdone, of course. The trend could merely be part of China's evolution toward developed-economy status. As its consumers become worldlier, credit card usage may be a sign of economic maturity.

Yet if South Korea, a far more advanced economy, could get into such trouble with credit cards, one wonders about China. Will a sudden taste for debt lead to financial troubles among Chinese consumers? The risk is one more to consider when assessing China's outlook.

Everyone seems to have a jaw-dropping statistic to put China's boom into perspective. Many focus on the country's insatiable demand for commodities like oil and steel. Or the waves of foreign direct investment rushing to China. Or its rapidly increasing military spending. Now another industry may soon be overwhelmed by the China effect: credit cards.

After generations of adhering to the Confucian aversion to debt, China is warming up to plastic. While data is hard to come by, the chief executive of American Express, Kenneth Chenault, said in December that credit card penetration in China was about 3 percent, and poised to surge.

Considering the size and growing affluence of China's population, it is easy to see why American Express, Citigroup and HSBC Holdings are showing interest. But can China avoid South Korea's household-debt blunder?

"It's clearly a mistake China wants to avoid," says Ifzal Ali, chief economist at the Manila-based Asian Development Bank.

From the ashes of the Asian financial crisis, South Korea quickly emerged as a role model for the region. It rebounded by strengthening its financial system, reducing foreign debt and reining in the conglomerates that dominate the economy. It encouraged banks to stop lending to shaky businesses, which had been a cause of the crisis.

Yet efforts to restore proper risk management in its banking system backfired. When they halted lending to the corporate sector, bankers turned their sights on households. Individual loans mushroomed, as did the number of credit cards lining consumers' wallets.

The trend proved disastrous. Soaring household debt and default rates drove the economy into recession and led to billions of dollars worth of bailouts for credit companies.

Before the crisis, South Koreans had little experience managing debt, to say nothing of high-interest-rate credit card debt. The lack of sophisticated systems for checking creditworthiness complicated matters. Walking the streets of Seoul between 1999 and 2002, one confronted a barrage of hawkers handing out credit-card applications.

It hardly helped that the government was encouraging credit card use with tax benefits. That drove banks and nonbank lenders to step up marketing efforts.

Feeling guilty and realizing how big a problem it had on its hands, the South Korean government organized bailouts. That sent a terrible message to markets. Credit card issuers extended credit to just about anyone who wanted it, and were left with surging delinquencies as the economy slowed and households couldn't service the debt.

Credit card companies over-leveraged to an extent that investors and regulators did not realize. Many of the loans were securitized through asset-backed securities. Most of the debt was short-term and had to be rolled over, meaning that the assets were not fully taken off balance sheets. And then, the government saved these gamblers.

Only now is South Korea shaking off the effects of these blunders. At last, its economy is growing again and households are confident enough to increase spending. While Chinese demand for Korean goods is certainly a factor, so are improved consumer finances.

China must be careful to avoid a Korea-like debt meltdown. With the benefit of hindsight, China may indeed do that. Besides, there is no guarantee that Chinese will take to plastic as, say, Americans have. The increasingly affluent middle class may, but will hundreds of millions of Chinese warm up to high-interest-rate debt?

Understandably, such risks aren't deterring credit card companies. The Chinese already rank among the world's most influential shoppers, buying more cellphones and televisions each year than U.S. consumers do. Yet Chinese demand is a small fraction of what it might be in 10 years.

Think what it would mean for issuers if even 20 percent of Chinese put two revolving credit cards in their wallet. And think of the consumption multiplier-effect that debt can produce. Debt, managed responsibly, has the potential to add momentum to Chinese consumption trends.

Serious consumer education, however, is needed. MasterCard International, for example, is working with banks, the media and universities to inform Chinese about the intricacies of debt management. China's government also has a big role to play.

Such concerns may be overdone, of course. The trend could merely be part of China's evolution toward developed-economy status. As its consumers become worldlier, credit card usage may be a sign of economic maturity.

Yet if South Korea, a far more advanced economy, could get into such trouble with credit cards, one wonders about China. Will a sudden taste for debt lead to financial troubles among Chinese consumers? The risk is one more to consider when assessing China's outlook.