CONTENTS
- 1. The Concept and Legal Meaning of an Insolvent Financial Institution
- - Legal Definition
- 2. Criteria for Determining an Insolvent Financial Institution
- - Factors in Assessing a Financial Institution's Soundness
- - The Process for Designating an Insolvent Financial Institution
- 3. Management Improvement Measures for Insolvent Financial Institutions
- - Stages of Prompt Corrective Action
- - Restructuring Measures After Designation as an Insolvent Financial Institution
- 4. Why a Legal Review of Insolvent Financial Institutions Is Needed
- - Key Legal Issues
- - Considerations for a Legal Response
1. The Concept and Legal Meaning of an Insolvent Financial Institution
An insolvent financial institution is one that the financial authorities designate as such when its financial condition has deteriorated to the point that normal operation is difficult.
Financial institutions carry out a range of transactions such as deposits, loans, and investments, and they manage the flow of funds across the economy as a whole.
A serious decline in such an institution's condition can affect the entire financial market, so the country maintains institutional safeguards to manage that risk.
In Korea, the rules governing financial-institution insolvency operate through several statutes and supervisory regulations, and the central statute is the Act on the Structural Improvement of the Financial Industry.
That Act allows the financial authorities to take the restructuring measures they consider necessary when a financial institution's condition is unsound.
Legal Definition
Article 2(2) of the Act on the Structural Improvement of the Financial Industry provides as follows.
2. The term "insolvent financial institution" means a financial institution that falls under any of the following items:
A. A financial institution whose liabilities exceed its assets according to an actual examination of its management condition, or a financial institution for which it is clear that liabilities will exceed assets and normal operation will be difficult because of a large-scale financial accident or the occurrence of nonperforming loans, as determined by the Financial Services Commission or by the Deposit Insurance Committee under Article 8 of the Depositor Protection Act. In this case, the valuation and calculation of liabilities and assets shall follow the standards set in advance by the Financial Services Commission.
B. A financial institution that has suspended the payment of deposits and other claims under Article 2, item 4 of the Depositor Protection Act (hereinafter referred to as "deposits and other claims" in this Article) or the repayment of borrowings from other financial institutions
C. A financial institution that the Financial Services Commission or the Deposit Insurance Committee under Article 8 of the Depositor Protection Act has found unable to pay deposits and other claims or to repay borrowings without outside support or separate borrowing (excluding borrowing that arises in the course of normal financial transactions)
This refers to a state in which key financial indicators, such as capital adequacy, ability to pay, and asset soundness, have deteriorated so that the institution can no longer perform its normal functions as a financial institution.
In other words, when a financial institution records continuous losses or its capital is eroded by a rise in nonperforming loans, weakening its ability to pay in a way that may affect the stability of the financial market, the financial authorities may treat it as an insolvent financial institution.
2. Criteria for Determining an Insolvent Financial Institution
Whether an institution is insolvent is determined through an overall assessment of its financial and management condition.
That assessment is carried out through the supervisory regulations of the Financial Supervisory Service and the management evaluation system for financial institutions.
Factors in Assessing a Financial Institution's Soundness
Assessment Factor | Meaning |
Capital adequacy | The level of capital available to absorb losses |
Asset soundness | The degree of impairment in assets such as loans |
Liquidity | The ability to repay short-term obligations |
Profitability | The ability to generate operating profit on a sustained basis |
Management | Internal controls and management stability |
The following factors are generally considered in assessing a financial institution's soundness, and they serve as the standard for an overall evaluation of its financial soundness and management stability.
The Process for Designating an Insolvent Financial Institution
Designation as an insolvent financial institution takes place through examination by the supervisory authority and a decision by the Financial Services Commission.
1) Examination by the Financial Supervisory Service
The Financial Supervisory Service reviews a financial institution's financial and management condition through regular or ad hoc examinations.
During an examination, it checks items such as the financial statements, capital ratios, the volume of nonperforming loans, the liquidity position, and the internal control system.
2) Designation decision by the Financial Services Commission
If the examination by the Financial Supervisory Service shows that the institution's soundness has deteriorated significantly, the Financial Services Commission reviews the institution's financial condition and its impact on the financial market as a whole and then decides whether to designate it.
3. Management Improvement Measures for Insolvent Financial Institutions
When a financial institution's soundness has deteriorated, the financial authorities may first apply staged management improvement measures rather than immediately designating it as an insolvent financial institution.
Stages of Prompt Corrective Action
Depending on how far a financial institution's soundness has deteriorated, the following measures may be taken.
Stage | Key Content |
Recommendation for management improvement | Recommendation to address management problems |
Requirement for management improvement | Requirement to submit a management improvement plan |
Order for management improvement | Mandatory management improvement measures |
These measures are designed to prompt a financial institution to improve its financial condition before it reaches a state of serious insolvency.
Restructuring Measures After Designation as an Insolvent Financial Institution
When the Financial Services Commission designates a financial institution as insolvent, various restructuring measures may be carried out.
Restructuring Method | Description |
Merger | Combining with another financial institution to restore normal operation |
Contract transfer | Transferring assets and liabilities to another financial institution |
Injection of public funds | Strengthening capital through government funds |
Liquidation | Dissolving the financial institution and winding up its assets |
These restructuring methods are applied selectively in light of the institution's financial condition and the stability of the financial market.
4. Why a Legal Review of Insolvent Financial Institutions Is Needed
The designation of an insolvent financial institution connects directly to a range of legal issues, including management control, claim relationships, and restructuring procedures.
Because designation can affect the rights and obligations of many stakeholders, a legal review of the relevant issues may be needed.
Key Legal Issues
Key Legal Issue | Description |
Management liability | Whether management bears responsibility, and internal control issues |
Changes in creditor-debtor relationships | Possible changes to contractual relationships during restructuring |
Restructuring procedures | Carrying out legal procedures such as merger, contract transfer, and liquidation |
Responding to supervisory measures | Review of supervisory measures by the Financial Services Commission and the Financial Supervisory Service |
Stakeholder disputes | Possible disputes among shareholders, creditors, and counterparties |
Considerations for a Legal Response
When reviewing a matter, it helps to consider the following factors together.
• Analysis of supervisory and administrative procedures of the financial authorities
• Review of stakeholder rights under the restructuring process
• Review of management liability and internal control issues at the financial institution
Daeryun Law Firm provides a range of legal advisory services on financial disputes and financial-institution restructuring matters.
The firm can review the legal issues that may arise from a financial institution's management problems or in the course of restructuring and consider a direction for response based on the relevant statutes and supervisory regulations.
It can also review the legal issues that may arise for stakeholders, such as companies and investors with a transactional relationship with the financial institution, and propose a legal response suited to the situation.
When a legal review is needed in connection with the designation of an insolvent financial institution or the restructuring of a financial institution, the facts of the case and the applicable statutes should be examined closely.
Daeryun Law Firm offers consultations on financial disputes and financial-institution restructuring matters, and through a 🔗legal consultation booking with a finance attorney, you can receive a review of the relevant laws together with guidance on a concrete direction for response.
