Institutionalization of the informal credit market and financial inclusion in Korea

Over the last half century, the Republic of Korea (South Korea) has experienced rapid, sustained economic growth, the social benefits of which have been relatively broad-based. Korea today also boasts a modern and deep financial system, and financial inclusion is high with nearly every Korean having access to basic financial services and products. With this in mind, better understanding of Korea’s financial development is an important key to unlocking the secret behind Korea’s economic miracle. In studying the development of Korea’s financial system (financial deepening), we find that Korea’s experience has been a long and winding road, a journey marked by a difficult struggle to govern the informal credit markets, which had at times dominated Korea’s financial sector early in its development.

In explaining the prominence of the informal credit market, the authors find that the difference in interest rates between the formal and informal sectors, above all, was the biggest determinant of the informal market’s role and size in Korea’s financial system during much of the 1960s and until the early 1980s.

Lastly, the paper discusses the institution of cooperative financial institutions (CFIs) in Korea, an experience usually not seen in other developing countries. CFIs have a long history and share a special place in Korea’s financial  development. CFIs were first introduced during Japanese colonial rule. It was not until the 1960s with the establishment and rapid growth of home-grown credit unions and cooperatives that financial inclusion began to improve in Korea.

Today, however, the industry is at a cross roads; Korean CFIs no longer operate like cooperatives. Moreover, a highly fragmented legal regulatory governing has resulted in 
an over-crowded CFI market and poor internal governance. The reform and reactivation of Korean CFIs poses a huge policy challenge. But it also offers an opportunity to address 
Korea’s growing income inequality, and its polarizing effect on society, by facilitating access to finance for the poorest and for young entrepreneurs.