This study looks into the financial regulatory and supervisory system of Korea's Merchant Banking Corporations prior to the currency crisis of 1997, which is regarded as one of the most important factors that led to the deterioration of Korea's financial system.

The results of this study show that prudential regulations and financial supervision on Merchant Banking Corporations were out of date and lacked strictness in many aspects such as licensing requirements, capital adequacy ratio, credit concentration, foreign exchange liquidity requirements, off shore investments, risk managements, and others.

Behind those outdated prudential regulations and loose supervision lies the anachronistic paradigm throughout the system, even in the modern era of foreign exchange liberalization, that the domestic currency and the foreign exchange business are totally separate and independent of each other.

We argue that the outdated prudential regulations coupled with loose supervision appears to be the main factor that led to the deterioration of the management of Korea's Merchant Banking Corporations, making Korea's financial system even more fragile before the outbreak of the currency crisis.