Since the outbreak of the financial crisis in 1997, an important implicit policy goal of the Korean government with respect to the financial system has been the transformation of the traditional bank-based system into a market-based one. The regulation on debt ratio imposed on large corporations is an important reflections of this goal. Following substantial policy efforts, the soundness of the corporate and the financial sectors has been largely improved. In this paper, however, we argue that the  financial system might still be premature as an efficient intermediation for corporate activities. The following points support our doubts about the current system:

First, the low debt ratio of the corporate sector is a more or less a direct consequence of the strongly enforced debt regulation, and as such, it is too early to say that this debt ratio is sustainable in the long run. In addition, the dramatic fall in the debt ratio has largely been driven by a decrease in firms' demand for investment funds. Moreover, blue-chip companies have been holding excessive cash and continues to play a role as the main supplier of funds, with the household sector as the main consumer of these funds, which is, in a sense, a reversal of the traditional intermediation process.

The capital markets still remain somewhat fragile to exogenous shocks and their role as an efficient resource allocations still needs to be strengthened. Corporate financing through capital markets remains less vigorous and the relative dependence of corporate financing on the banking system is again on the rise. However, the size of funds from banks as of 2003 is almost the same as the size in 1997, which implies that the banks' financial support for the corporate sector is still dwindling. At the same time, long-term corporate financing for large-scale investments has almost disappeared.

Based on these observations, we argue that the govern-ment's attempts to build a market-based financial system, despite improvements in the soundness of the corporate and financial sectors, is still far from building an efficient financial system for corporate activities. A major reason for this failure, we believe, is that the system transformation has not been concomitant with a well-functioning financial infrastructure.

We argue that achieving an efficient corporate financing system should start from strengthening financial infrastructure that includes enhancing efficiency in the creation and circulation process of financial information, deregulation of financial services, elimination of unnecessary regulations, development of a junk-bond market, diversification of bond maturities, amongst others. At the same time, efforts to enhance a firm's transparency as well as strengthening market discipline should be continuously made.

Considering the fact that the capital markets are not functioning well and remain fragile to exogenous shocks, it is important to increase the efficiency of resource allocation through bank or bank-like financial institutions. In order to do this, unnecessary government intervention should be mitigated in the loan markets, and rather, fostering financial institutions that specialize in corporate loans and which reduce the pro-cyclicality of the BIS capital regulations should be emphasized as important policy objectives.