Creating a good bank for North Korea

Among the most important approaches to the current financial crisis is the creation of "bad banks," which take up problematic, "poisonous" assets and try to turn them around and sell them off. South Korea after the crisis of 1997-98 gained experience with the quite successful Korea Asset Management Corporation. For North Korea, however, the situation might reverse: a good bank is needed, a bank which can fulfill the classic banking functions without political interference, in the most transparent manner to refute any doubt about the legitimacy of financial transactions at that bank.

The sanctions of the U.N. Security Council, which answered the recent missile and nuclear tests of North Korea, will probably not achieve their intended goal to cut off North Korea from financing its illicit activities. This is particularly true in terms of proliferation of arms, but also in other terms like drug trafficking, counterfeiting an smuggling. The related departments of state, party and army are many and it is questionable how far they depend on a sound financial system for their success in business.



Where is the problem?



We can presume the sanctions, or rather the warnings the U.S. Department of Treasury issued, are justified. Time and again North Korea has ignored the rules of international trade and financial transfers have played a major role in various illicit activities. The potential misuses of the international financial system are manifold and range from money laundering and circulating counterfeited money to insurance scams. North Korea has been accused of all of them.

However, there is a problem. Together with dubious transactions legal transactions will also be hurt. One could even assume that legal transactions are hurt much more than illegal transactions. By their nature legal activities cannot easily turn to alternative ways of financing, such as cash transactions, which are feasible, though not comfortable, for illegal trade.

Cutting off both legal and illegal trade might be justifiable under two conditions: First, the goal of sanctions should be to strangle North Korea; second, the sanctions should be able to achieve this goal. However, both conditions are not met. As officials not only from China and Russia, but also from South Korea and the United States have repeatedly said, sanctions are not intended to coerce North Korea by weakening its economy, they are simply meant to contain North Korea`s illicit activities. Even if a hidden agenda of coercion is assumed, it will not work. As long as China, and to some extent Russia, do not start to isolate North Korea in terms of border trade, the United States and the rest of the world are simply not able to influence North Korea in this way.

Recent research by Marcus Noland showed that after the sanctions imposed in October 2006, trade with China grew steadily. And North Korea does not really need other trading partners, as long as a minimum of imports is guaranteed consisting of goods distributed to the elite, in particular luxury goods, necessary military and technology inputs and some residual food needed to sustain the population at the meager rates it has become used to during the last two decades.

So, while legitimate as well as illicit trade might go underground and resort to cash transactions, life for the population might worsen, if that is possible, but the goal of sanctions will not be achieved.

Since North Korea opened up during the great famine of the mid-1990s, the European Union, its member states and European NGOs have taken various initiatives to increase legitimate trade and business in North Korea as an alternative to illicit trade. Capacity-building for the trade and financial sector played an important role in this endeavor. Swedish institutions like the Royal Institute of Technology and the Stockholm School of Economics were involved in training programs for the financial sector and German Hanns Seidel Foundation carried out the EU-DPRK trade capacity project, which tried to find ways to develop North Korean exports. These goals are certainly far from achieved, not least due to North Korean political behavior and the lack of commitment to economic reform in its leadership.

However, at the working level participants in training units are enthusiastic to embrace new knowledge. Certainly, training also generates demand for applying the new knowledge and by this it can be hoped to contribute to the goal to integrate North Korea peacefully into the world economy.

Nevertheless, this is at best a long-term option and maybe, more can be done. But it has to be radically different from the current approach. Capacity-building for national North Korean banks and trade institutions, as long as it can be carried out, is good, and the fact that one North Korean joint venture bank has a foreign manager helps to create a technocracy more knowledgeable about the role of banks and finance in the modern economy.

<**2>

But still, even these institutions cannot escape overarching political goals and the fact that other institutions have no more access to the international financial system due to the warnings issued by the U.S. Department of Treasury might even make the remaining institutions more the target of political, undesirable demands from the North Korean leadership. It is difficult to imagine that such institutions will ever gain the transparency trust necessary for integration in the international banking system.

The alternative is an international solution: Create a good bank for North Korea. Such a bank, however, should not be burdened by the tricky and highly political preconditions set by the current international financial institutions, such as the Asian Development Bank (ADB), International Monetary Fund or World Bank.

Though the membership conditions of these institutions are crucial to guarantee a maximum of compatibility with the international financial system, they cannot be met by any institution in North Korea. Rather, the alternative is a bank of non-North Korean origin that is open to all legitimate transactions by North Korean entities. The creation of such a bank would fit into a scenario where positive offers accompany new sanctions. This does not mean the offers are new carrots for North Korea -- which did not work in the past -- but in the form of offering policy innovations to the country while bearing in mind the limited room for such initiatives that North Korea`s political system allows. The good bank for North Korea would fit these preconditions.

Regional development banks throughout the world have already proved their usefulness for economic development, in particular during times of economic transformation. Besides the aforementioned ADB and World Bank, the European Bank for Reconstruction and Development (EBRD), in its short history, was a major force for reintegration of Eastern European and post-Soviet states into the world economy. It also helped to finance large-scale investment in those countries and foster the market economy through capacity-building. In Central Asia, the newly-founded Eurasian Development Bank, though currently restricted to Russia and Kazakhstan, might play a similar role in future.

A Northeast Asian Development Bank (NADB) has already been proposed by several authors since the beginning of the 1990s. Unlike the ADB, a strong offer should be made to North Korea to participate from the beginning. Funding could be regional, most probably from South Korea and China, but also Japan and non-Asian states and entities like the EU. Capacity-building should be, besides regional project funding, a main task of such a bank.

It would be important that such a development bank was not seen as a "watered-down" international financial institution. Political credit guarantees for economically nonviable projects (which however are also not completely alien to existing financial institutions) would only make the institution prone to political attacks and would not be helpful for North Korea in the long run.

In this respect, investment projects should be submitted to an "IFI-test," asking if other international financial institutions (IFI) also would carry out the project under their standards. The difference, however, would be that the political burden of the existing international financial institution would not exist. Though U.S. membership of the NADB might be desirable, no veto on political grounds for this institution should exist. North Korea should be barred from state membership -- the offers to the North should be limited to provision of services.

What would be the role of the NADB? As the name says, the first task of the bank would be regional development projects. A sectoral focus on cross-border energy, the environment and transportation issues could be beneficial immediately in the region, regardless of North Korea`s involvement. Developing an energy pipeline network for the future, jointly fighting challenges like desertification in China that hurt other Northeast Asian countries, and developing transport links in the region. Perhaps interregional networks like the "iron silk road" could be considered another important issue.

Financial sector development and integration must be the second main function of the NADB. Capacity-building in all areas, but in particular the financial sector, would help achieve the goals of the bank.

Finally, the NADB could offer a commercial banking arm. The Northeast Asian Commercial Bank (NACB) could offer commercial banking particularly -- but not solely -- to North Korea. Operating under strict transparency rules, it would be open to all kinds of legitimate transactions under commercial standards, but with the political backing of the funding governments.

The NADB would also be helpful in addressing an additional problem, which often is forgotten but will resurface once more immediate political and economic concerns are resolved. North Korea, like some other socialist and developing countries, defaulted on its external debt in the 1980s. This problem has to be resolved as a precondition for the re-integration of North Korea in the world economy.

This does not mean North Korea has to pay back all of that debt -- principal plus interest -- which is not possible in the foreseeable future. Looking at the experience of debt rescheduling of Soviet and Russian debt with the London Club (of private lenders) and Paris Club (of state lenders), it can be said that the process was helpful beyond solving the original problem. A new generation of debt and trade finance specialists emerged, more understanding for international trade followed and economic reform was forwarded by negotiations. Creating macroeconomic specialist, debt and trade finance specialists would be as well a precondition as an outcome of negotiations. In both, the NADB could play a pivotal role.

In a second step, the NADB could also assume the debt (where the possibility of repayment currently is anyway zero) after large write-offs, and for concessions in terms of reform in North Korea. A strong linkage of capacity-building, aid and trade would result.

Overall, the NADB would have four functions: financing regional development projects, capacity-building, commercial banking for North Korea and the creation of a bad bank within for old North Korean debt. One main question still remains unanswered: Can North Korea really be lured into international cooperation? Is that not the same approach which failed many times in the past?

Certainly, it would be illusionary to think that North Korea would immediately come on board. But the proposal itself is not unrealistic and would have immediate positive effects: More regional cooperation, in particular in view of the North Korean situation, would be good for the region and would enhance an understanding of the newly emerging five-party grouping.

Resolving current problems goes hand in hand with developing solutions for North Korea. Extending an olive branch to North Korea, particularly in the form of a regional initiative that includes China, would put pressure on North Korea to react positively.

It would also show the population of North Korea, which by now has at least limited access to information from abroad, that the international community is not hostile vis-a-vis North Korea, but offering help.

This would open various possibilities: The most benign, but currently least probable, would be that North Korea itself becomes interested in capacity-building and economic integration. A more probable outcome, would be that growing Chinese frustration with its ally would lead to stronger Chinese efforts to convince North Korea to open up. There is no guarantee that the NADB will succeed with regard to North Korea. However, a lot of money has been spent on much more dubious inter-Korean cooperation projects to no avail. This approach might well be worth trying out.

By Bernhard Seliger