Form 20-F
Table of Contents

As filed with the Securities and Exchange Commission on June 28, 2007

 


UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


FORM 20-F


(Mark One)

 

¨ REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     .

OR

 

¨ SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Date of event requiring this shell company report                     .

Commission file number 001-15258


Kookmin Bank

(Exact name of Registrant as specified in its charter)


Kookmin Bank

(Translation of Registrant’s name into English)


The Republic of Korea

(Jurisdiction of incorporation or organization)

9-1, 2-ga, Namdaemoon-ro, Jung-gu, Seoul 100-703, Korea

(Address of principal executive offices)

Securities registered or to be registered pursuant to Section 12(b) of the Act.

 

Title of each class

 

Name of each exchange on which registered

American Depositary Shares, each representing

one share of Common Stock

  New York Stock Exchange
Common Stock, par value (Won)5,000 per share   New York Stock Exchange*

Securities registered or to be registered pursuant to Section 12(g) of the Act.

None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.

None

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

336,379,116 shares of Common Stock, par value (Won)5,000 per share

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    x  Yes    ¨  No

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.    ¨  Yes    x  No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  Yes    ¨  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

x  Large accelerated filer                    ¨  Accelerated filer                    ¨  Non-accelerated filer

Indicate by check mark which financial statement item the registrant has elected to follow.    ¨  Item 17    x  Item 18

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨  Yes    x  No

(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    ¨  Yes    ¨  No

 

* Not for trading, but only in connection with the registration of the American Depositary Shares.

 



Table of Contents

TABLE OF CONTENTS

 

PRESENTATION OF FINANCIAL AND OTHER INFORMATION

   1

FORWARD-LOOKING STATEMENTS

   2

Item 1.

 

IDENTITY OF DIRECTORS, SENIOR MANAGERS AND ADVISERS

   3

Item 2.

 

OFFER STATISTICS AND EXPECTED TIMETABLE

   3

Item 3.

 

KEY INFORMATION

   3
 

Item 3A. Selected Financial Data

   3
 

Item 3B. Capitalization and Indebtedness

   11
 

Item 3C. Reasons for the Offer and Use of Proceeds

   11
 

Item 3D. Risk Factors

   11

Item 4.

 

INFORMATION ON THE COMPANY

   29
 

Item 4A. History and Development of the Company

   29
 

Item 4B. Business Overview

   32
 

Item 4C. Organizational Structure

   94
 

Item 4D. Property, Plants and Equipment

   95

Item 4.A.

 

UNRESOLVED STAFF COMMENTS

   96

Item 5.

 

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

   96
 

Item 5A. Operating Results

   96
 

Item 5B. Liquidity and Capital Resources

   121
 

Item 5C. Research and Development, Patents and Licenses, etc.

   139
 

Item 5D. Trend Information

   139
 

Item 5E. Off-Balance Sheet Arrangements

   139
 

Item 5F. Tabular Disclosure of Contractual Obligations

   139

Item 6.

 

DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

   139
 

Item 6A. Directors and Senior Management

   139
 

Item 6B. Compensation

   143
 

Item 6C. Board Practices

   144
 

Item 6D. Employees

   147
 

Item 6E. Share Ownership

   148

Item 7.

 

MAJOR STOCKHOLDERS AND RELATED PARTY TRANSACTIONS

   150
 

Item 7A. Major Stockholders

   150
 

Item 7B. Related Party Transactions

   150
 

Item 7C. Interest of Experts and Counsel

   151

Item 8.

 

FINANCIAL INFORMATION

   151
 

Item 8A. Consolidated Statements and Other Financial Information

   151
 

Item 8B. Significant Changes

   155

Item 9.

 

THE OFFER AND LISTING

   155
 

Item 9A. Offering and Listing Details

   155

 

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Item 9B. Plan of Distribution

   157
 

Item 9C. Markets

   157
 

Item 9D. Selling Shareholders

   164
 

Item 9E. Dilution

   164
 

Item 9F. Expenses of the Issuer

   164

Item 10.

 

ADDITIONAL INFORMATION

   164
 

Item 10A. Share Capital

   164
 

Item 10B. Memorandum and Articles of Association

   164
 

Item 10C. Material Contracts

   170
 

Item 10D. Exchange Controls

   171
 

Item 10E. Taxation

   172
 

Item 10F. Dividends and Paying Agents

   176
 

Item 10G. Statements by Experts

   176
 

Item 10H. Documents on Display

   176
 

Item 10I. Subsidiary Information

   176

Item 11.

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

   176

Item 12.

 

DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

   195

Item 13.

 

DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

   195

Item 14.

 

MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

   195

Item 15.

 

CONTROLS AND PROCEDURES

   195

Item 16.

 

RESERVED

   196
 

Item 16A. Audit Committee Financial Expert

   196
 

Item 16B. Code of Ethics

   196
 

Item 16C. Principal Accountant Fees and Services

   196
 

Item 16D. Exemptions from the Listing Standards for Audit Committees

   197
 

Item 16E. Purchase of Equity Securities by the Issuer and Affiliated Purchasers

   197

Item 17.

 

FINANCIAL STATEMENTS

   197

Item 18.

 

FINANCIAL STATEMENTS

   197

Item 19.

 

EXHIBITS

   197

 

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PRESENTATION OF FINANCIAL AND OTHER INFORMATION

As of and for the years ended December 31, 2002, 2003, 2004, 2005 and 2006, we have prepared financial information in accordance with United States generally accepted accounting principles, or U.S. GAAP. Unless indicated otherwise, the financial information in this annual report as of and for the years ended December 31, 2002, 2003, 2004, 2005 and 2006 has been prepared in accordance with U.S. GAAP.

In this annual report:

 

   

references to “we,” “us” or “Kookmin Bank” are to Kookmin Bank and, unless the context otherwise requires, its subsidiaries and, for periods of time prior to the merger with H&CB, the former Kookmin Bank;

 

   

references to “Korea” are to the Republic of Korea;

 

   

references to the “government” are to the government of the Republic of Korea;

 

   

references to “Won” or “(Won)” are to the currency of Korea; and

 

   

references to “U.S. dollars,” “$” or “US$” are to United States dollars.

Discrepancies between totals and the sums of the amounts contained in any table may be a result of rounding.

For your convenience, this annual report contains translations of Won amounts into U.S. dollars at the noon buying rate of the Federal Reserve Bank of New York for Won in effect on December 29, 2006, which was (Won)930.0 = US$1.00.

 

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FORWARD-LOOKING STATEMENTS

The U.S. Securities and Exchange Commission encourages companies to disclose forward-looking information so that investors can better understand a company’s future prospects and make informed investment decisions. This annual report contains forward-looking statements.

Words and phrases such as “aim,” “anticipate,” “assume,” “believe,” “contemplate,” “continue,” “estimate,” “expect,” “future,” “goal,” “intend,” “may,” “objective,” “plan,” “predict,” “positioned,” “project,” “risk,” “seek to,” “shall,” “should,” “will likely result,” “will pursue,” “plan” and words and terms of similar substance used in connection with any discussion of future operating or financial performance or our expectations, plans, projections or business prospects identify forward-looking statements. In particular, the statements under the headings “Item 3D. Risk Factors,” “Item 5. Operating and Financial Review and Prospects” and “Item 4B. Business Overview” regarding our financial condition and other future events or prospects are forward-looking statements. All forward-looking statements are management’s present expectations of future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements.

In addition to the risks related to our business discussed under “Item 3D. Risk Factors,” other factors could cause actual results to differ materially from those described in the forward-looking statements. These factors include, but are not limited to:

 

   

our ability to successfully implement our strategy;

 

   

future levels of non-performing loans;

 

   

our growth and expansion;

 

   

the adequacy of allowance for credit and investment losses;

 

   

technological changes;

 

   

interest rates;

 

   

investment income;

 

   

availability of funding and liquidity;

 

   

cash flow projections;

 

   

our exposure to market risks; and

 

   

adverse market and regulatory conditions.

By their nature, certain disclosures relating to these and other risks are only estimates and could be materially different from what actually occurs in the future. As a result, actual future gains, losses or impact on our income or results of operations could materially differ from those that have been estimated. For example, revenues could decrease, costs could increase, capital costs could increase, capital investment could be delayed and anticipated improvements in performance might not be fully realized.

In addition, other factors that could cause actual results to differ materially from those estimated by the forward-looking statements contained in this annual report could include, but are not limited to:

 

   

general economic and political conditions in Korea or other countries that have an impact on our business activities or investments;

 

   

the monetary and interest rate policies of Korea;

 

   

inflation or deflation;

 

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unanticipated volatility in interest rates;

 

   

foreign exchange rates;

 

   

prices and yields of equity and debt securities;

 

   

the performance of the financial markets in Korea and globally;

 

   

changes in domestic and foreign laws, regulations and taxes;

 

   

changes in competition and the pricing environments in Korea; and

 

   

regional or general changes in asset valuations.

For further discussion of the factors that could cause actual results to differ, see the discussion under “Item 3D. Risk Factors” contained in this annual report. We caution you not to place undue reliance on the forward-looking statements, which speak only as of the date of this annual report. Except as required by law, we are not under any obligation, and expressly disclaim any obligation, to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise.

All subsequent forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this annual report.

 

Item 1. IDENTITY OF DIRECTORS, SENIOR MANAGERS AND ADVISERS

Not applicable

 

Item 2. OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable

 

Item 3. KEY INFORMATION

 

Item 3A. Selected Financial Data

The selected consolidated financial and operating data set forth below as of and for the years ended December 31, 2002, 2003, 2004, 2005 and 2006 have been derived from our audited consolidated financial statements, which have been prepared in accordance with U.S. GAAP. Our consolidated financial statements as of and for the years ended December 31, 2002, 2003 and 2004 have been audited by independent registered public accounting firm Samil PricewaterhouseCoopers and our consolidated financial statements as of and for the years ended December 31, 2005 and 2006 have been audited by independent registered public accounting firm Deloitte Anjin LLC.

You should read the following data together with the more detailed information contained in “Item 5. Operating and Financial Review and Prospects” and our consolidated financial statements included elsewhere in this annual report. Historical results do not necessarily predict future results.

 

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Consolidated income statement data

 

    Year ended December 31,  
    2002     2003     2004   2005   2006     2006(1)  
    (in billions of Won, except common share data)     (in millions
of US$, except
common
share data)
 

Interest and dividend income

  (Won) 13,450     (Won) 13,755     (Won) 12,092   (Won) 10,658   (Won) 11,405     US$ 12,263  

Interest expense

    6,734       6,462       5,516     4,757     5,342       5,744  
                                           

Net interest income

    6,716       7,293       6,576     5,901     6,063       6,519  

Provision for credit losses

    3,886       7,167       3,861     613     (100 )     (107 )

Non-interest income

    3,098       2,914       2,800     2,844     2,880       3,096  

Non-interest expense

    4,387       4,406       4,032     4,314     4,522       4,862  

Income tax expense (benefit)

    597       (367 )     448     1,099     1,423       1,530  

Minority interests

    (211 )     (52 )     3     3     5       5  

Net income (loss) from continuing operations

    1,155       (947 )     1,032     2,716     3,093       3,325  

Net (loss) income from discontinued operations after income taxes

    97       —         —       —       —         —    

Cumulative effect of accounting change, net of tax

    —         —         —       —       (2 )     (2 )
                                           

Net income (loss)

  (Won) 1,252     (Won) (947 )   (Won) 1,032   (Won) 2,716   (Won) 3,091     US$ 3,323  
                                           

Net income (loss) from continuing operations per common share

           

Net income (loss)—basic

  (Won) 3,633     (Won) (2,905 )   (Won) 3,367   (Won) 8,415   (Won) 9,194     US$ 9.89  

Net income (loss)—diluted (2)

    3,535       (2,905 )     3,365     8,411     9,193       9.88  

Net income (loss) per common share

           

Net income (loss)—basic

  (Won) 3,939     (Won) (2,905 )   (Won) 3,367   (Won) 8,415   (Won) 9,189     US$ 9.88  

Net income (loss)—diluted (2)

    3,831       (2,905 )     3,365     8,411     9,188       9.87  

Weighted average common shares outstanding-basic (in thousands of common shares)

    317,787       326,000       306,432     322,786     336,351       336,351  

Weighted average common shares outstanding-diluted (in thousands of common shares)

    328,107       326,000       306,650     322,948     336,353       336,353  

Cash dividends paid per common share (3)

  (Won) 100     (Won) 1,000       —     (Won) 550   (Won) 550     US$ 0.59  

(1)

Won amounts are expressed in U.S. dollars at the rate of (Won)930.0 to US$1.00, the noon buying rate in effect on December 29, 2006 as quoted by the Federal Reserve Bank of New York in the United States.

(2)

Diluted earnings per share gives effect to the potential dilution that could occur if convertible securities, options or other contracts to issue common stock were converted into or exercised for common stock for the relevant periods. Effective from 2003, we had one category of potentially dilutive common shares, which was shares issuable on exercise of stock options granted to directors and employees.

(3)

U.S. GAAP requires that dividends be recorded in the period in which they are declared rather than the period to which they relate unless these are the same.

 

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Consolidated balance sheet data

 

     Year ended December 31,
     2002    2003     2004    2005    2006    2006(1)
     (in billions of Won)    (in millions
of US$)

Assets

                

Cash and cash equivalents

   (Won) 3,328    (Won) 3,170     (Won) 2,818    (Won) 3,086    (Won) 3,775    US$ 4,059

Restricted cash

     1,580      2,770       1,822      2,259      3,277      3,524

Interest-bearing deposits in other banks

     564      563       597      515      423      455

Call loans and securities purchased under resale agreements

     229      3,959       2,993      1,716      1,738      1,869

Trading assets

     6,368      3,517       6,096      4,754      3,744      4,026

Investments (2)

     24,223      22,427       23,095      25,372      25,348      27,256

Loans (net of allowance for loan losses of (Won)5,195 billion in 2002, (Won)5,772 billion in 2003, (Won)4,461 billion in 2004 (Won)3,212 billion in 2005 and (Won)2,468 billion in 2006)

     140,756      140,213       133,794      134,939      149,216      160,447

Due from customers on acceptances

     881      605       743      627      620      667

Premises and equipment, net

     2,121      1,909       1,637      1,516      1,612      1,733

Accrued interest and dividends receivable

     1,116      995       871      1,060      802      862

Security deposits

     1,337      1,331       1,285      1,185      1,190      1,280

Goodwill

     162      395       422      394      394      424

Other intangible assets, net

     469      423       308      217      185      199

Other assets

     965      1,702       1,055      868      654      702
                                          

Total assets

   (Won) 184,099    (Won) 183,979     (Won) 177,536    (Won) 178,508    (Won) 192,978    US$ 207,503
                                          

Liabilities and Stockholders’ Equity

                

Deposits:

                

Interest bearing

   (Won) 118,654    (Won) 128,144     (Won) 123,203    (Won) 121,787    (Won) 125,195    US$ 134,618

Non-interest bearing

     3,745      3,460       3,017      3,912      4,345      4,672

Call money

     306      225       652      1,253      168      180

Trading liabilities

     625      762       2,297      1,078      1,223      1,315

Acceptances outstanding

     881      605       743      627      620      667

Other borrowed funds

     15,856      12,895       9,514      6,118      10,627      11,427

Accrued interest payable

     4,463      3,938       3,495      3,307      3,698      3,977

Secured borrowings

     7,864      8,207       6,121      8,118      7,463      8,024

Long-term debt

     20,165      16,607       17,899      16,751      21,675      23,306

Other liabilities

     2,634      2,552       2,900      4,151      3,174      3,415
                                          

Total liabilities

     175,193      177,395       169,841      167,102      178,188      191,601
                                          

Minority interests

     71      16       13      14      18      19

Common stock

     1,641      1,682       1,682      1,682      1,682      1,808

Additional paid-in capital

     5,146      5,393       5,400      5,416      5,404      5,810

Other

     2,048      (507 )     600      4,294      7,686      8,265
                                          

Stockholders’ equity

     8,835      6,568       7,682      11,392      14,772      15,883
                                          

Total liabilities, minority interests and stockholders’ equity

   (Won) 184,099    (Won) 183,979     (Won) 177,536    (Won) 178,508    (Won) 192,978    US$ 207,503
                                          

(1)

Won amounts are expressed in U.S. dollars at the rate of (Won)930.0 to US$1.00, the noon buying rate in effect on December 29, 2006 as quoted by the Federal Reserve Bank of New York in the United States.

(2)

Consists of available-for-sale securities, held-to-maturity securities, venture capital securities and other securities.

 

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Profitability ratios and other data

 

     Year ended December 31,  
     2002     2003     2004     2005     2006  
     (percentages)  

Net income as a percentage of:

          

Average total assets (1)

   0.71 %   (0.49 )%   0.56 %   1.50 %   1.61 %

Average stockholders’ equity (1)

   13.50     (7.17 )   13.36     25.51     22.52  

Dividend payout ratio (2)

   1.80     —       16.33     6.81     39.73  

Net interest spread (3)

   3.71     3.68     3.62     3.29     3.15  

Net interest margin (4)

   4.02     4.01     3.84     3.53     3.43  

Efficiency ratio (5)

   44.70     43.17     43.00     49.33     50.56  

Cost-to-average assets ratio (6)

   2.49     2.28     2.19     2.38     2.36  

Won loans (gross) as a percentage of Won deposits

   115.68     108.30     108.00     106.34     112.16  

Total loans (gross) as a percentage of total deposits

   119.14     110.83     109.43     109.80     116.88  

(1)

Average balances are based on daily balances for our primary banking operations and monthly or quarterly balances for our subsidiaries.

(2)

Represents the ratio of total dividends declared on common stock as a percentage of net income.

(3)

Represents the difference between the yield on average interest earning assets and cost of average interest bearing liabilities.

(4)

Represents the ratio of net interest income to average interest earning assets.

(5)

Represents the ratio of non-interest expense to the sum of net interest income and non-interest income.

(6)

Represents the ratio of non-interest expense to average total assets.

Capital ratios

 

     Year ended December 31,  
     2002     2003     2004     2005     2006  
     (percentages)  

Total capital adequacy ratio (1)

   10.41 %   9.81 %   11.01 %   12.95 %   14.17 %

Tier I capital adequacy ratio (1)

   6.62     6.03     6.67     9.67     10.07  

Tier II capital adequacy ratio (1)

   3.79     3.78     4.34     3.28     4.10  

Average stockholders’ equity as a percentage of average total assets

   5.26     6.83     4.20     5.87     7.17  

(1)

Our capital adequacy ratios are computed in accordance with the guidelines issued by the Financial Supervisory Commission. The computation is based on our consolidated financial statements prepared in accordance with Korean GAAP, which may differ in certain significant respects from U.S. GAAP. See “Item 5B. Liquidity and Capital Resources—Financial Condition—Capital Adequacy.”

Credit portfolio ratios and other data

 

    As of December 31,  
    2002     2003     2004     2005     2006  
    (in billions of Won, except percentages)  

Total loans

  (Won) 145,832     (Won) 145,858     (Won) 138,124     (Won) 138,012     (Won) 151,403  

Total non-performing loans (1)

    3,912       4,116       3,175       3,149       2,143  

Other impaired loans not included in non-performing loans

    2,680       3,072       2,034       1,615       1,195  

Total of non-performing loans and other impaired loans

    6,592       7,188       5,209       4,764       3,338  

Total allowance for loan losses

    5,195       5,772       4,461       3,212       2,468  

Non-performing loans as a percentage of total loans

    2.68 %     2.82 %     2.30 %     2.28 %     1.42 %

Non-performing loans as a percentage of total assets

    2.13       2.24       1.79       1.76       1.11  

Total of non-performing loans and other impaired loans as a percentage of total loans

    4.52       4.93       3.77       3.45       2.21  

Allowance for loan losses as a percentage of total loans

    3.56       3.96       3.23       2.33       1.63  

(1)

Non-performing loans are defined as those loans, including corporate, retail and other loans, which are past due more than 90 days.

 

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Selected Statistical Information

Average Balance Sheets and Related Interest

The following table shows our average balances and interest rates for the past three years:

 

     Year ended December 31,  
     2004     2005     2006  
     Average
balance(1)
    Interest
income(2)(3)(4)
   Average
yield
    Average
balance(1)
    Interest
income(2)(3)(4)
   Average
yield
    Average
balance(1)
    Interest
income(2)(3)(4)
   Average
yield
 
     (in billions of Won, except percentages)  

Assets

                     

Cash and interest-earning deposits in other banks

   (Won) 1,188     (Won) 21    1.77 %   (Won) 1,069     (Won) 27    2.53 %   (Won) 860     (Won) 28    3.26 %

Call loans and securities purchased under resale agreements

     2,355       85    3.61       2,378       78    3.28       1,415       60    4.24  

Trading securities

     3,253       156    4.80       3,342       129    3.86       3,318       159    4.79  

Investment securities (5)

     20,030       1,004    5.01       23,357       960    4.11       27,605       1,217    4.41  

Loans:

                     

Commercial and industrial

     42,369       2,639    6.23       39,031       2,352    6.03       44,631       2,694    6.04  

Construction loans

     4,718       309    6.55       4,283       284    6.63       5,194       349    6.72  

Other commercial

     926       43    4.64       1,295       65    5.02       1,514       86    5.68  

Mortgage and home equity

     55,863       3,607    6.46       58,376       3,355    5.75       60,373       3,724    6.17  

Other consumer

     27,287       2,197    8.05       24,506       2,002    8.17       22,046       1,811    8.21  

Credit cards (4)

     12,049       1,978    16.42       8,369       1,362    16.27       8,547       1,221    14.29  

Foreign commercial and industrial

     1,342       53    3.95       1,219       44    3.61       1,152       56    4.86  
                                                               

Loans (total)

     144,554       10,826    7.49       137,079       9,464    6.90       143,457       9,941    6.93  
                                                               

Total average interest earning assets

     171,380       12,092    7.06       167,225       10,658    6.37       176,655       11,405    6.46  
                                                               

Cash and due from banks

     5,062       —      —         4,997       —      —         5,102       —      —    

Foreign exchange spot contracts and derivatives

     4,839       —      —         5,786       —      —         5,798       —      —    

Premises and equipment

     2,052       —      —         1,641       —      —         1,504       —      —    

Due from customers on acceptance

     532       —      —         1,092       —      —         594       —      —    

Loan loss allowance

     (5,373 )     —      —         (3,844 )     —      —         (2,396 )     —      —    

Assets of discontinued operations

                     

Other non-interest earning assets

     5,610       —      —         4,411       —      —         4,261       —      —    
                                                               

Total average non-interest earning assets

     12,722       —      —         14,083       —      —         14,863       —      —    
                                                               

Total average assets

   (Won) 184,102     (Won) 12,092    6.57     (Won) 181,308     (Won) 10,658    5.88     (Won) 191,518     (Won) 11,405    5.96  
                                                   

 

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     Year ended December 31,  
     2004     2005     2006  
     Average
balance(1)
   Interest
expense
   Average
cost
    Average
balance(1)
   Interest
expense
   Average
cost
    Average
balance(1)
   Interest
expense
   Average
cost
 
     (in billions of Won, except percentages)  

Liabilities

                        

Deposits:

                        

Demand deposits

   (Won) 620    (Won) 1    0.16 %   (Won) 614    (Won) 7    1.14 %   (Won) 625    (Won) 11    1.76 %

Certificates of deposit

     6,107      248    4.06       5,007      185    3.69       8,386      379    4.52  

Other time deposits

     68,230      2,716    3.98       66,229      2,388    3.61       62,015      2,433    3.92  

Savings deposits

     39,042      309    0.79       38,343      219    0.57       41,652      296    0.71  

Mutual installment deposits

     12,105      560    4.63       10,589      382    3.61       8,511      289    3.40  
                                                

Deposits (total)

     126,104      3,834    3.04       120,782      3,181    2.63       121,189      3,408    2.81  

Call money

     1,267      42    3.31       1,218      40    3.28       2,825      119    4.21  

Borrowings from the Bank of Korea

     911      22    2.41       687      14    2.04       653      15    2.30  

Other short-term borrowings

     8,150      310    3.80       7,474      275    3.68       7,574      339    4.48  

Secured borrowings

     7,400      366    4.95       7,109      310    4.36       8,622      389    4.51  

Long-term debt

     16,749      942    5.62       17,114      937    5.48       20,285      1,072    5.28  
                                                

Total average interest bearing liabilities

     160,581      5,516    3.44       154,384      4,757    3.08       161,148      5,342    3.31  
                                                

Demand deposits

     2,832      —      —         3,010      —      —         3,173      —      —    

Foreign exchange spot contracts and derivatives

     4,840      —      —         5,748      —      —         5,739      —      —    

Acceptances to customers

     652      —      —         760      —      —         593      —      —    

Other non-interest bearing liabilities

     7,472      —      —         6,759      —      —         7,139      —      —    
                                                

Total average non-interest bearing liabilities

     15,796      —      —         16,277      —      —         16,644      —      —    
                                                

Total average liabilities

     176,377      5,516    3.13       170,661      4,757    2.79       177,792      5,342    3.00  
                                                

Stockholders’ equity

     7,725      —      —         10,647      —      —         13,726      —      —    
                                                

Total liabilities and stockholders’ equity

   (Won) 184,102    (Won) 5,516    3.00     (Won) 181,308    (Won) 4,757    2.62     (Won) 191,518    (Won) 5,342    2.79  
                                                

(1)

Average balances are based on daily balances for our primary banking operations and monthly or quarterly balances for our subsidiaries.

(2)

Interest income figures include dividends on securities and cash interest received on non-accruing loans. See “Item 4B. Business Overview—Assets and Liabilities—Loan Portfolio—Non-Accrual Loans and Past Due Accruing Loans.”

(3)

We do not invest in any tax-exempt securities.

(4)

Interest income from credit cards includes principally cash advance fees of (Won)1,148 billion, (Won)880 billion and (Won)708 billion and interest on credit card loans of (Won)430 billion, (Won)217 billion and (Won)274 billion for the years ended December 31, 2004, 2005 and 2006, respectively.

(5)

Information related to investment securities classified as available-for-sale has been computed using amortized cost, and therefore does not give effect to changes in fair value that are reflected as a component of stockholders’ equity.

 

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The following table presents our net interest spread, net interest margin, and asset liability ratio for the past three years:

 

     Year ended December 31,  
     2004     2005     2006  
     (percentages)  

Net interest spread (1)

   3.62 %   3.29 %   3.15 %

Net interest margin (2)

   3.84     3.53     3.43  

Average asset liability ratio (3)

   106.72     108.32     109.62  

(1)

The difference between the average rate of interest earned on interest earning assets and the average rate of interest paid on interest bearing liabilities.

(2)

The ratio of net interest income to average interest earning assets.

(3)

The ratio of average interest earning assets to average interest bearing liabilities.

Analysis of Changes in Net Interest Income—Volume and Rate Analysis

The following table provides an analysis of changes in interest income, interest expense and net interest income based on changes in volume and changes in rate for 2005 compared to 2004 and 2006 compared to 2005. Information is provided with respect to: (1) effects attributable to changes in volume (changes in volume multiplied by prior rate) and (2) effects attributable to changes in rate (changes in rate multiplied by prior volume). Changes attributable to the combined impact of changes in rate and volume have been allocated proportionately to the changes due to volume changes and changes due to rate changes.

 

     2005 vs. 2004
Increase/(decrease)
due to change in
    2006 vs. 2005
Increase/(decrease)
due to change in
 
     Volume     Rate     Total     Volume     Rate     Total  
     (in billions of Won)  

Interest earning assets

            

Cash and interest earning deposits in other banks

   (Won) (2 )   (Won) 8     (Won) 6     (Won) (6 )   (Won) 7     (Won) 1  

Call loans and securities purchased under resale agreements

     1       (8 )     (7 )     (37 )     19       (18 )

Trading securities

     4       (31 )     (27 )     (1 )     31       30  

Investment securities

     152       (196 )     (44 )     184       73       257  

Loans

            

Commercial and industrial

     (203 )     (84 )     (287 )     338       4       342  

Construction loans

     (29 )     4       (25 )     61       4       65  

Other commercial

     18       4       22       12       9       21  

Mortgage and home equity

     157       (409 )     (252 )     117       252       369  

Other consumer

     (227 )     32       (195 )     (202 )     11       (191 )

Credit cards

     (599 )     (17 )     (616 )     28       (169 )     (141 )

Foreign commercial and industrial

     (5 )     (4 )     (9 )     (3 )     15       12  
                                                

Total interest income

     (733 )     (701 )     (1,434 )     491       256       747  
                                                

 

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     2005 vs. 2004
Increase/(decrease)
due to change in
    2006 vs. 2005
Increase/(decrease)
due to change in
 
     Volume     Rate     Total     Volume     Rate     Total  
     (in billions of Won)  

Interest bearing liabilities

            

Deposits:

            

Demand deposits

     0       6       6       0       4       4  

Certificates of deposit

     (42 )     (21 )     (63 )     146       48       194  

Other time deposits

     (78 )     (250 )     (328 )     (158 )     203       45  

Savings deposits

     (5 )     (85 )     (90 )     20       57       77  

Mutual installment deposits

     (65 )     (113 )     (178 )     (72 )     (21 )     (93 )

Call money

     (2 )     0       (2 )     65       14       79  

Borrowings from the Bank of Korea

     (5 )     (3 )     (8 )     (1 )     2       1  

Other short-term borrowings

     (25 )     (10 )     (35 )     4       60       64  

Secured borrowings

     (14 )     (42 )     (56 )     68       11       79  

Long-term debt

     20       (25 )     (5 )     169       (34 )     135  
                                                

Total interest expense

     (216 )     (543 )     (759 )     241       344       585  
                                                

Total net interest income

   (Won) (517 )   (Won) (158 )   (Won) (675 )   (Won) 250     (Won) (88 )   (Won) 162  
                                                

Exchange Rates

The tables below set forth, for the periods and dates indicated, information concerning the noon buying rate for Won, expressed in Won per one U.S. dollar. The “noon buying rate” is the rate in New York City for cable transfers in foreign currencies as certified for customs purposes by the Federal Reserve Bank of New York. Unless otherwise stated, translations of Won amounts into U.S. dollars in this annual report were made at the noon buying rate in effect on December 29, 2006, which was (Won)930.0 to US$1.00. We do not intend to imply that the Won or U.S. dollar amounts referred to herein could have been or could be converted into U.S. dollars or Won, as the case may be, at any particular rate, or at all. On June 27, 2007, the noon buying rate was (Won)927.4 = US$1.00.

 

     Won per U.S. dollar (noon buying rate)
     Low    High    Average(1)    Period-End

2002

   (Won) 1,160.6    (Won) 1,332.0    (Won) 1,242.0    (Won) 1,186.3

2003

     1,146.0      1,262.0      1,193.0      1,192.0

2004

     1,035.1      1,195.1      1,139.3      1,035.1

2005

     997.0      1,059.8      1,023.8      1,010.0

2006

     913.7      1,002.9      954.3      930.0

2007 (through June 27)

           

January

     925.4      942.2      936.8      941.0

February

     932.5      942.3      936.9      942.3

March

     937.2      949.1      942.9      941.1

April

     926.1      937.0      930.7      931.0

May

     922.3      934.0      927.6      927.4

June (through June 27)

     926.1      932.3      928.2      927.4

Source: Federal Reserve Bank of New York.

(1)

The average of the daily noon buying rates of the Federal Reserve Bank in effect during the relevant period (or portion thereof).

 

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Item 3B. Capitalization and Indebtedness

Not Applicable

 

Item 3C. Reasons for the Offer and Use of Proceeds

Not Applicable

 

Item 3D. Risk Factors

Risks relating to our retail credit portfolio

Future changes in market conditions as well as other factors may lead to increases in delinquency levels of our retail loan portfolio.

In recent years, consumer debt has increased rapidly in Korea. As the leading retail bank in Korea, our portfolio of retail loans, in particular, mortgage and home equity loans, has grown from (Won)60,506 billion as of December 31, 2001 to (Won)85,571 billion as of December 31, 2006. As of December 31, 2006, our retail loans represented 56.5% of our total lending. Within our retail loan portfolio, the outstanding balance of other consumer loans, which unlike mortgage or home equity loans is often unsecured and therefore tends to carry a higher credit risk, has decreased from (Won)23,312 billion as of December 31, 2001 to (Won)21,589 billion as of December 31, 2006; as a percentage of total outstanding retail loans, such balance has also decreased from 38.5% as of December 31, 2001 to 25.2% as of December 31, 2006. The growth of our retail lending business, which generally offers higher margins than other lending activities, contributed significantly to our interest income and profitability in recent years. Although the size of our retail portfolio decreased in 2005 due to increased delinquencies in 2003 and 2004, heightened competition and government regulation in the retail loan lending segment, in 2006 our retail portfolio increased primarily as a result of increases in mortgage and home equity loans.

The growth of our retail loan portfolio in prior years led to significant increases in delinquency levels in 2003 and 2004, although delinquency levels stabilized starting in 2005. Higher delinquencies in 2003 and 2004 required us to increase our loan loss provisions and charge-offs, which in turn adversely affected our financial condition and results of operations. While our non-performing retail loans (defined as those that are over 90 days past due) decreased from (Won)1,046 billion as of December 31, 2001 to (Won)628 billion as of December 31, 2006 due to the relative stabilization of delinquency levels from 2005, there is no assurance that delinquency levels for our retail loans will not rise in the future.

Our large exposure to consumer debt means that we are exposed to changes in economic conditions affecting Korean consumers. Accordingly, a rise in unemployment, an increase in interest rates, a downturn in the real estate market, or a general contraction or other difficulties in the Korean economy that have an adverse effect on Korean consumers could result in reduced growth and further deterioration in the credit quality of our retail loan portfolio. In order to minimize our risk as a result of such exposure, we are continuing to strengthen our risk management processes, including further improving the retail lending process, upgrading our retail credit rating system, as well as strengthening the overall management of our portfolio. Despite our efforts, however, there is no assurance that we will be able to prevent significant credit quality deterioration in our retail loan portfolio.

Until 2004, our credit card operations recorded losses, and may again generate losses in the future, which could hurt our financial condition and results of operations.

In September 2003, we merged Kookmin Credit Card, our credit card subsidiary, into us in response to its liquidity problems stemming from the deteriorating asset quality of its credit card portfolio. The acquisition of minority interest was accounted for under the purchase method of accounting, and we stepped up the assets and

 

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liabilities acquired to their fair values at the date of acquisition. The excess of fair value of purchase consideration over the fair value of net assets acquired was recognized as goodwill. Following the merger, our credit card operations continued to record significant additional net losses through the first three quarters of 2004. This was primarily due to high delinquency levels and substantial charge-offs and loan loss provisions. Our delinquency ratio (which represents the ratio of amounts that are overdue by one day or more to total outstanding balances) with respect to our credit card portfolio was 20.6%, 21.6%, 8.42%, 5.8% and 4.81% as of December 31, 2002, 2003, 2004, 2005 and 2006, respectively. While our strengthened risk management efforts have resulted in recent decreases in the delinquency ratio, credit card delinquencies may increase in the future as a result of, among other things, adverse economic developments in Korea and the inability of Korean consumers to manage increased household debt, as reflected in the persistent practice among some credit cardholders of obtaining multiple credit cards and using cash advances from one card to make payments due on others.

In addition, in line with industry practice, we have restructured a large portion of delinquent credit card account balances (defined as balances overdue for one day or more) as loans and also replaced a portion of our delinquent credit card account balances with cash advances that are rolled over from month to month. We have discontinued the practice of providing substituted cash advances from January 2004. As of December 31, 2006, these restructured loans outstanding amounted to (Won)135 billion. Because these loans are not treated as being delinquent at the time of conversion or for a period of time thereafter, our delinquency ratios may not fully reflect all delinquent amounts relating to our outstanding loans. Including all restructured loans, outstanding balances overdue by one day or more accounted for 5.85% of our credit card receivables (including credit card loans) as of December 31, 2006.

Despite our recent successful efforts to improve our credit card asset quality and performance, we may again experience losses on our credit card operations in the future, which may adversely affect our overall financial condition and results of operations.

Risk relating to our small- and medium-sized enterprise loan portfolio

We have significant exposure to small- and medium-sized enterprises, and any financial difficulties experienced by these customers may result in a deterioration of our asset quality and have an adverse impact on us.

One of our core businesses is lending to small- and medium-sized enterprises (as defined under “Item 4B. Business Overview—Corporate Banking—Small- and Medium-sized Enterprise Banking”). We estimate, based on our internal classifications made for Korean GAAP purposes, that our loans to small- and medium-sized enterprises increased from (Won)30,498 billion as of December 31, 2001 to (Won)41,498 billion as of December 31, 2006. During that period, we estimate that non-performing loans to small- and medium-sized enterprises also increased from (Won)1,108 billion to (Won)1,451 billion, although the non-performing loan ratio for such loans decreased from 3.6% as of December 31, 2001 to 3.5% as of December 31, 2006. According to data compiled by the Financial Supervisory Service, the delinquency ratio for Won-currency loans by Korean commercial banks to small- and medium-sized enterprises was 1.2% as of December 31, 2006. As of December 31, 2006, the delinquency ratio for loans to small- and medium-sized enterprises was calculated as the ratio of (1) the outstanding balance of such loans in respect of which either principal payments are overdue by one day or more or interest payments are overdue by 14 days or more (unless prior interest payments on a loan were made late on more than three occasions, in which case the loan is considered delinquent if interest payments are overdue by one day or more) to (2) the aggregate outstanding balance of such loans. Our delinquency ratio for such Won-currency loans on a Korean GAAP basis decreased from 3.3% as of December 31, 2001 to 1.04% as of December 31, 2006 but may rise again in the future. From January 1, 2007, the delinquency ratio for small- and medium-sized enterprise is calculated as the ratio of (1) the outstanding balance of such loans in respect of which either principal or interest payments are over due by one month or more to (2) the aggregate outstanding balance of such loans. Accordingly, we are taking measures to stem rising delinquencies in our loans to small- and medium-sized enterprises, including through strengthening the review of loan applications and closer

 

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monitoring of the post-loan performance of small- and medium-sized enterprise borrowers in industry sectors that are relatively more sensitive to downturns in the economy and have shown higher delinquency ratios, such as construction, hotels, restaurants and real estate. Despite such efforts, however, there is no assurance that delinquency levels for our loans to small- and medium-sized enterprises will not rise in the future.

Among other things, aggressive marketing and intense competition among banks in the small- and medium-sized enterprise lending market contributed to a deterioration in profitability and in the asset quality of our loans to this segment, especially in 2003 and 2004. Such deterioration also led to increased charge-offs and higher provisioning and reduced interest and fee income from this segment during such periods. The ability of our small- and medium-sized enterprise customers to service their debt may be further undermined by adverse economic developments in the future, including sustained high levels of oil prices and other raw material costs or the continued strength of the Won leading to reduced competitiveness for exported Korean goods, which may lead to further deterioration in the asset quality of our loans to such customers. In addition, many small- and medium-sized enterprises have close business relationships with the largest Korean commercial conglomerates, known as “chaebols,” primarily as suppliers. Any difficulties encountered by those chaebols would likely hurt the liquidity and financial condition of related small- and medium-sized enterprises, including those to which we have exposure, also resulting in an impairment of their ability to repay loans.

A substantial part of our small- and medium-sized enterprise lending comprises loans to “small office/home office” customers, or SOHOs. Many of these SOHOs represent sole proprietorships, individual business interests or very small corporations and are usually dependent on a limited number of suppliers or customers. SOHOs tend to be affected to a greater extent than larger corporate borrowers by fluctuations in the Korean economy. In addition, SOHOs often maintain less sophisticated financial records than other corporate borrowers. Although we are making efforts to improve our internally developed credit rating systems to rate potential borrowers, we do not have a substantial history of experience with SOHOs and are less able to judge the level of risk inherent in these customers. Accordingly, although we intend to manage our exposure to these borrowers closely in order to prevent any deterioration in the asset quality of our loans to this segment, we may not be able to do so.

Risks relating to our strategy

Although increasing our fee income is an important part of our strategy, we may not be able to do so.

We have historically relied on interest income as our primary revenue source. While we have developed new sources of fee income as part of our business strategy, our ability to increase our fee income and thereby reduce our dependence on interest income will be affected by the extent to which our customers generally accept the concept of fee-based services. The willingness of customers to pay fees in return for value-added financial services has not been broadly tested in the Korean market and their reluctance to do so will adversely affect the implementation of this aspect of our strategy.

In March 2007, we reduced or waived many of the fees we charge on our banking services, in response to customer demand. Specifically, we reduced or waived our fees on fund transfers through our Internet, mobile and telephone banking services, as well as on transfers and after-hour withdrawals through ATMs. We also reduced our wire transfer fees and eliminated the fees we charge on issuance of bankers’ checks and certain tax-related statements. These measures may result in a significant reduction in our banking-related fee income.

We may suffer customer attrition or our net interest margin may decrease as a result of our competition strategy.

We have been pursuing, and intend to continue to pursue, a strategy of maintaining or enhancing our margins where possible and avoid, to the extent possible, entering into price competition. In order to execute this strategy, we will need to maintain relatively low interest rates on our deposit products while charging relatively higher rates on loans. If other banks and financial institutions adopt a strategy of expanding market share through

 

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interest rate competition, we may suffer customer attrition due to rate sensitivity. In addition, we may in the future decide to compete to a greater extent based on interest rates, which could lead to a decrease in our net interest margins. Any future decline in our customer base or our net interest margins as a result of our future competition strategy could have an adverse effect on our results of operations and financial condition.

Risks relating to competition

Competition in the Korean banking industry is intense, and we may experience declining market share as a result.

We compete principally with other financial institutions in Korea, including Korean banks and branches of foreign banks operating in Korea. In the retail and small- and medium-sized enterprise lending business, which has been our traditional core business, competition has increased significantly and is expected to increase further. Most Korean banks have been targeting retail customers and small- and medium-sized enterprises as they scale back their exposure to large corporate borrowers, contributing to some extent to the asset quality deterioration in consumer and small- and medium-sized enterprise loans, and they are engaged in aggressive marketing campaigns and making significant investments in these segments. In addition, the profitability of our retail and credit card operations may decline as a result of growing market saturation in the retail lending and credit card segments, increased interest rate competition, pressure to lower the fee rates applicable to our credit cards (particularly merchant fee rates) and higher marketing expenses. Intense and increasing competition has made and continues to make it more difficult for us to secure retail, credit card and small- and medium-sized customers with the credit quality and on credit terms necessary to achieve our business objectives in a commercially acceptable manner.

In addition, we believe regulatory reforms and the general modernization of business practices in Korea will lead to increased competition among financial institutions in Korea. We also believe that foreign financial institutions, many of which have greater experience and resources than we do, will seek to compete with us in providing financial products and services either by themselves or in partnership with existing Korean financial institutions. Furthermore, a number of significant mergers and acquisitions in the industry have taken place in Korea over the last few years, including the acquisition of Koram Bank by an affiliate of Citibank in 2004 and Standard Chartered Bank’s acquisition of Korea First Bank in 2005, as well as Chohung Bank’s merger with Shinhan Bank in April 2006. We expect that consolidation in the financial industry will continue. Some of the financial institutions resulting from this consolidation may, by virtue of their increased size and business scope, provide significantly greater competition for us. Increased competition and continuing consolidation may lead to decreased margins, resulting in a material adverse impact on our future profitability. Accordingly our results of operations and financial condition may suffer as a result of increasing competition in the Korean financial industry.

We face full competition with respect to our mortgage business, which may result in a further decrease of our market share and adversely affect our margins.

We were formed through a merger between the former Kookmin Bank and H&CB in 2001. Until 1997, by law, H&CB was the only financial institution in Korea that could offer a full range of mortgage products. Among other things, it had the exclusive ability to offer mortgages with terms longer than ten years, provide housing-related deposit accounts and offer preferential rights to subscribe for newly built apartments.

In 1997, the laws giving H&CB exclusive rights to offer these mortgage-related products began to be repealed. By March 2000, all commercial banks in Korea could offer a full range of mortgage products, and H&CB began to lose market share. The increased competition in the mortgage sector has also contributed to lower margins from our mortgage lending activities. While we continue to hold the largest share of this market, we may not be able to maintain our market share or margins with respect to mortgage lending in the face of increased competition. Any decrease in such market share or margins may adversely affect our financial condition and results of operations.

 

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Risks relating to our large corporate loan portfolio

We have exposure to chaebols, and, as a result, recent and any future financial difficulties of chaebols may have an adverse impact on us.

Of our 20 largest corporate exposures (including loans, debt and equity securities, guarantees and acceptances and other exposures) as of December 31, 2006, eight were to companies that were members of the 36 largest chaebols in Korea. As of that date, the total amount of our exposures to the 36 largest chaebols was (Won)11,005 billion, or 6.0% of our total exposures. If the credit quality of our exposures to chaebols declines, we could require substantial additional loan loss provisions, which would hurt our results of operations and financial condition. See “Item 4B. Business Overview—Assets and Liabilities—Loan Portfolio—Exposure to Chaebols.”

We cannot assure you that the allowances we have established against these exposures will be sufficient to cover all future losses arising from these exposures. In addition, with respect to those companies that are in or in the future enter into workout or liquidation proceedings, we may not be able to make any recoveries against such companies. We may, therefore, experience future losses with respect to those loans.

We have exposure to companies that are currently or may in the future be put in restructuring, and we may suffer losses as a result of additional loan loss provisions required and/or the adoption of restructuring plans with which we do not agree.

As of December 31, 2006, our loans and guarantees to companies that were in workout or court-supervised restructuring (including composition and corporate reorganization) amounted to (Won)701 billion or 0.4% of our total loans and guarantees, of which (Won)295 billion or 42.1% was classified as substandard or below and all of which was classified as impaired. As of the same date, our allowances for losses on these loans and guarantees amounted to (Won)274 billion, or 39.1% of these loans and guarantees. These allowances may not be sufficient to cover all future losses arising from our exposure to these companies. Furthermore, we have other exposure to such companies, in the form of debt and equity securities of such companies held by us (including equity securities we acquired as a result of debt-to-equity conversions). Our exposures with respect to such securities as of December 31, 2006 to companies in workout or court-supervised restructuring (including composition and corporate reorganization) amounted to (Won)843 billion, or 0.5% of our total exposures. In addition, in the case of borrowers that are or become subject to workout, we may be forced to restructure our credits pursuant to restructuring plans approved by other creditor financial institutions holding 75% or more of the total outstanding debt (as well as 75% or more of the total outstanding secured debt) of the borrower, or to dispose of our credits to other creditors on unfavorable terms.

Our current allowances for losses on loans and guarantees to construction companies may not be sufficient to cover all future related losses.

We have established allowances for losses on loans and guarantees to construction companies that we consider to have a greater likelihood of becoming non-performing. As of December 31, 2006, we had loans and guarantees outstanding to construction companies in the amount of (Won)6,697 billion, or 4.3% of our total loans and guarantees, of which (Won)242 billion or 3.6% was classified as substandard or below. As of the same date, our allowance for losses on these loans and guarantees amounted to (Won)144 billion, or 59.5% of the amount classified as substandard or below, and 2.2% of the total. Most of our exposure to construction companies consists of loans to small- and medium-sized enterprises. These allowances may not be sufficient to cover all future losses arising from our exposure to construction companies.

A large portion of our credit exposure is concentrated in a relatively small number of large corporate borrowers, which increases the risk of our corporate credit portfolio.

As of December 31, 2006, our loans and guarantees to our 20 largest borrowers totaled (Won)8,570 billion and accounted for 5.5% of our total loans and guarantees. As of that date, our single largest corporate credit exposure

 

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was to Hyundai Heavy Industries, to which we had outstanding credit exposures (all of which was in the form of guarantees and acceptances) of (Won)1,472 billion, representing 0.9% of our total loans and guarantees. Any further deterioration in the financial condition of our large corporate borrowers may require us to take substantial additional provisions and may have a material adverse impact on our results of operations and financial condition.

Other risks relating to our business

We are generally subject to Korean corporate governance and disclosure standards, which may differ from those in other countries.

Companies in Korea, including us, are subject to corporate governance standards applicable to Korean public companies which may differ in some respects from standards applicable in other countries, including the United States. As a reporting company registered with the U.S. Securities and Exchange Commission and listed on the New York Stock Exchange, we are subject to certain corporate governance standards as mandated by the Sarbanes-Oxley Act of 2002. However, foreign private issuers, including us, are exempt from certain corporate governance requirements under the Sarbanes-Oxley Act or under the rules of the New York Stock Exchange. There may also be less publicly available information about Korean companies, such as us, than is regularly made available by public or non-public companies in other countries. Such differences in corporate governance standards and less public information could result in corporate governance practices or disclosures that are perceived as less than satisfactory by investors in certain countries.

A decline in the value of the collateral securing our loans and our inability to realize full collateral value may adversely affect our credit portfolio.

A substantial portion of our loans is secured by real estate, the values of which have fluctuated significantly in recent years. Although it is our general policy to lend up to 40% to 60% of the appraised value of collateral (except in areas of high speculation designated by the government where we are required to limit our lending to 40% of the appraised value of collateral) and to periodically re-appraise our collateral, downturns in the real estate markets in Korea from time to time have resulted in declines in the value of the collateral securing some loans to levels below their outstanding principal balance. Future declines in real estate prices, including as a result of measures recently adopted by the Korean government to stabilize the real estate market, would reduce the value of the collateral securing our mortgage and home equity loans. If collateral values decline in the future, they may not be sufficient to cover uncollectible amounts in respect of our secured loans. Any declines in the value of the real estate or other collateral securing our loans, or our inability to obtain additional collateral in the event of such declines, could result in a deterioration in our asset quality and may require us to take additional loan loss provisions.

In Korea, foreclosure on collateral generally requires a written petition to a court. An application, when made, may be subject to delays and administrative requirements that may result in a decrease in the value realized with respect to such collateral. We cannot guarantee that we will be able to realize the full value on our collateral as a result of, among other factors, delays in foreclosure proceedings and defects in the perfection of our security interest in collateral. Our failure to recover the expected value of collateral could expose us to losses.

The secondary market for corporate bonds in Korea is not fully developed, and, as a result, we may not be able to realize the full “marked-to-market” value of debt securities we hold at the time of any sale of such securities.

As of December 31, 2006, we held debt securities issued by Korean companies and financial institutions (other than those issued by government-owned or -controlled enterprises or financial institutions, which include the Korea Electric Power Corporation, the Bank of Korea, the Korea Development Bank and the Industrial Bank of Korea) with a total book value of (Won)2,847 billion in our trading and investment securities portfolio. The

 

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market value of these securities could decline significantly due to various factors, including future increases in interest rates, which may be significant in light of the current low interest environment, or a deterioration in the financial and economic condition of any particular issuer or of Korea in general. Any of these factors individually or a combination of these factors would require us to write down the fair value of these debt securities, resulting in impairment losses. Because the secondary market for corporate bonds in Korea is not fully developed, the market value of many of these securities as reflected on our balance sheet is determined by references to suggested prices posted by Korean rating agencies or the Korea Securities Dealers Association. These valuations, however, may differ significantly from the actual value that we could realize in the event we elect to sell these securities. As a result, we may not be able to realize the full “marked-to-market” value at the time of any such sale of these securities and thus may incur losses.

We may be assessed additional income taxes in respect of prior years as a result of a tax audit by the National Tax Service of Korea.

During the first half of 2007, the National Tax Service of Korea completed a tax audit in respect of us for the fiscal years 2002, 2003, 2004 and 2005, as a result of which we were assessed (Won)190 billion for tax deficiencies. We recorded the entire amount of the additional income tax in our consolidated financial statements as of December 31, 2006 as “Income Tax Expenses” and “Other Liabilities” in accordance with SFAS No. 5 “Accounting for Contingencies” and have paid a substantial portion of such additional tax in June 2007. We plan to appeal such assessment to the National Tax Tribunal. The National Tax Service of Korea is also reviewing whether to assess additional income taxes for prior years based on its tax audit, and the amount of any such additional tax assessment may be significant.

We may be required to make transfers from our general banking operations to cover shortfalls in our guaranteed trust accounts, which could have an adverse effect on our results of operations.

We manage a number of money trust accounts. Under Korean law, trust account assets of a bank are required to be segregated from the assets of that bank’s general banking operations. Those assets are not available to satisfy the claims of a bank’s depositors or other creditors of its general banking operations. For some of the trust accounts we manage, we have guaranteed the principal amount of the investor’s investment. Since January 2004, banks have been prohibited from providing new trust accounts that guarantee the principal amount of investments, other than certain retirement trust and annuity trust products. However, we will continue to provide guarantees with respect to existing accounts, which contain the aforementioned guarantee provisions.

If, at any time, the income from our guaranteed trust accounts is not sufficient to pay any guaranteed amount, we will have to cover the shortfall first from the special reserves maintained in these trust accounts, then from our fees from such trust accounts and finally from funds transferred from our general banking operations. As of December 31, 2006, we had (Won)60 billion as special reserves in trust account assets for which we provided guarantees of principal. There were no significant transfers from general banking operations to cover deficiencies in guaranteed trust accounts in 2004, 2005 and 2006. However, we may be required to make transfers from our general banking operations to cover shortfalls, if any, in our guaranteed trust accounts in the future. Such transfers may adversely impact our results of operations.

Our Internet banking services are subject to security concerns relating to the commercial use of the Internet.

We provide Internet banking services to our retail and corporate customers, which require sensitive customer information, including passwords and account information, to be transferred over a secure connection on the Internet. However, connections on the Internet, although secure, are not free from security breaches. We may experience security breaches or unexpected disruptions in connection with our Internet banking service in the future, which may result in liability to our customers and third parties and have an adverse effect on our business or reputation.

 

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We may experience disruptions, delays and other difficulties from our information technology systems.

We rely on our information technology systems for our daily operations including customer service, transactions, billing and record keeping. We may experience disruptions, delays or other difficulties from our information technology systems, which may have an adverse effect on our business and adversely impact our customers’ confidence in us.

We do not prepare interim financial information on a U.S. GAAP basis.

Neither we nor our subsidiaries are required to, and we and our subsidiaries do not, prepare interim financial information on a U.S. GAAP basis. U.S. GAAP differs in significant respects from Korean GAAP, particularly with respect to the establishment of provisions and loan loss allowance. See “Item 5B. Liquidity and Capital Resources—Selected Financial Information under Korean GAAP” and “—Reconciliation with Korean GAAP.” As a result, our provision and allowance levels reflected under Korean GAAP in our results as of the end of and for 2002, 2003, 2004, 2005 and 2006 may differ significantly from comparable figures under U.S. GAAP for these and future periods.

Risks relating to liquidity and capital management

A considerable increase in interest rates could decrease the value of our debt securities portfolio and raise our funding costs while reducing loan demand and the repayment ability of our borrowers, which, as a result, could adversely affect us.

From 2000 to 2004, interest rates in Korea declined to historically low levels as the government sought to stimulate economic growth through active rate-lowering measures. Interest rates started to rebound in the second half of 2005 and have stabilized in 2006. The vast majority of debt securities we hold pay interest at a fixed rate. However, all things being equal and assuming that the interest rate sensitivity gap of our assets and liabilities is narrow, a considerable increase in interest rates would lead to a decline in the value of the debt securities in our portfolio. A sustained increase in interest rates will also raise our funding costs, while reducing loan demand, especially among consumers. A considerable rise in interest rates may therefore require us to rebalance our assets and liabilities in order to minimize the risk of potential mismatches and maintain our profitability.

In addition, rising interest rate levels may adversely affect the Korean economy and the financial condition of our corporate and retail borrowers, including holders of our credit cards, which in turn may lead to a deterioration in our credit portfolio. Since most of our retail and corporate loans bear interest at rates that adjust periodically based on prevailing market rates, a sustained increase in interest rate levels will increase the interest costs of our retail and corporate borrowers and could adversely affect their ability to make payments on their outstanding loans.

Our funding is highly dependent on short-term deposits, which dependence may adversely affect our operations.

We meet a significant amount of our funding requirements through short-term funding sources, which consist primarily of customer deposits. As of December 31, 2006, approximately 92.1% of our deposits had maturities of one year or less or were payable on demand. In the past, a substantial proportion of our customer deposits have been rolled over upon maturity. We cannot guarantee, however, that depositors will continue to roll over their deposits in the future. In particular, we estimate that increases in our short-term deposits in prior years were attributable in large part to the lack of alternative investment opportunities for individuals and households in Korea, especially in light of the low interest rate environment and volatile stock market conditions. Accordingly, a substantial number of our short-term deposit customers may withdraw their funds or fail to roll over their deposits if higher-yielding investment opportunities emerge. In that event, our liquidity position could be adversely affected. We may also be required to seek more expensive sources of short-term and long-term funding to finance our operations.

 

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We may be required to raise additional capital to maintain our capital adequacy ratios, which we may not be able to do on favorable terms or at all.

Pursuant to the capital adequacy requirements of the Financial Supervisory Commission, we are required to maintain a minimum Tier I capital adequacy ratio of 4.0% and a combined Tier I and Tier II capital adequacy ratio of 8.0%, on a consolidated Korean GAAP basis. Tier II capital is included in calculating the combined Tier I and Tier II capital adequacy ratio up to 100% of Tier I capital. As of December 31, 2006, our Tier I capital adequacy ratio was 10.07% and our combined Tier I and Tier II capital adequacy ratio was 14.17%, which exceeded the minimum levels required by the Financial Supervisory Commission. However, our capital base and capital adequacy ratio may deteriorate in the future if our results of operations or financial condition deteriorates for any reason, including as a result of a deterioration in the asset quality of our retail loans (including credit card balances) and loans to small- and medium-sized enterprises, or if we are not able to deploy our funding into suitably low-risk assets.

If our capital adequacy ratio deteriorates, we may be required to obtain additional Tier I or Tier II capital in order to remain in compliance with the applicable capital adequacy requirements. We may not be able to obtain additional capital on favorable terms, or at all. Our ability to obtain additional capital at any time may be constrained to the extent that banks or other financial institutions in Korea or from other Asian countries are seeking to raise capital at the same time. To the extent that we fail to maintain our capital adequacy ratios in the future, Korean regulatory authorities may impose penalties on us ranging from a warning to suspension or revocation of our license. For a description of the capital adequacy requirements of the Financial Supervisory Commission, see “Item 5B. Liquidity and Capital Resources—Financial Condition—Capital Adequacy.”

We may face increased capital requirements under the new Basel Capital Accord.

In June 2006, the Financial Supervisory Service announced that it would implement the new Basel Capital Accord, referred to as Basel II, in Korea beginning on January 1, 2008. The implementation of Basel II will have a substantial effect on the way risk is measured among Korean financial institutions, including us. Building upon the initial Basel Capital Accord of 1988, which focused primarily on market risk and capital adequacy and asset soundness as measures of risk, Basel II expands this approach to contemplate additional areas of risk such as operational risk. Our implementation of Basel II may require an increase in our capital requirements, which may require us to either improve our asset quality or raise additional capital.

In addition, under Basel II, we are permitted to follow either a standardized approach or an internal ratings-based approach with respect to calculating credit risk capital requirements. We have voluntarily chosen to establish and follow an internal ratings-based approach, which is more risk-sensitive in assessing our credit risk capital requirements. For regulatory reporting purposes, we are planning to implement a “Foundation Internal Ratings-based Approach” for credit risk and a standardized approach for operational risk from January 1, 2008, with the “Advanced Internal Ratings-based Approach” and “Advanced Measurement Approach” being implemented for credit risk and operational risk, respectively, from January 2009. For internal measurement purposes, we began to implement the Advanced Internal Ratings-based Approach for credit risk and Advanced Measurement Approach for operational risk commencing in 2007. We recently conducted a Quantitative Impact Study (or QIS) as of December 31, 2006, in accordance with instructions from the Financial Supervisory Service. The results of the QIS indicated that our capital adequacy ratio increased under the internal ratings-based approach, whereas our capital adequacy ratio decreased marginally under the standardized approach. Such QIS results, however, are based on preliminary data, and it is possible that our internal ratings-based approach may require an increase in our credit risk capital requirements, which may require us to either improve our asset quality or raise additional capital. Furthermore, the supervisory accreditation of our internal ratings-based approach will not be determined until the second half of 2007, and more detailed and reliable analysis of the impact of the implementation of Basel II will not be available until the second half of 2007 when we begin the parallel measurement of our capital adequacy ratios under both our previous approach under the initial Basel Capital Accord of 1988 and our new Basel II approaches.

 

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See “Item 5A. Operating Results—Overview—New Basel Capital Accord” and “Item 5B. Liquidity and Capital Resources—Financial Condition—Capital Adequacy.”

Risks relating to government regulation and policy

New loan loss provisioning guidelines implemented by the Financial Supervisory Commission may require us to increase our provisioning levels under Korean GAAP, which could adversely affect us.

In recent years, the Financial Supervisory Commission has implemented changes to the loan loss provisioning requirements applicable to Korean banks under Korean GAAP, which have resulted in increases to the Bank’s provisions and have adversely impacted the Bank’s reported results of operations and financial condition under Korean GAAP. Until 2004, the requirement to establish allowances for possible losses in respect of confirmed acceptances and guarantees applied only to those classified as substandard or below. Commencing in the second half of 2005, the requirement was extended to cover confirmed acceptances and guarantees classified as normal or precautionary, as well as unconfirmed acceptances and guarantees and bills endorsed. Similarly, until 2004, the requirement to establish other allowances in respect of unused credit lines applied only to the unused credit limit for cash advances on active credit card accounts, defined as those with a transaction recorded during the past year. Commencing in the second half of 2005, the requirement was extended to cover the unused credit limit for credit card purchases on active accounts, as well as the unused credit limit on consumer and corporate loans. These changes resulted in a significant increase in our allowance for acceptances and guarantees and other allowances under Korean GAAP, and a corresponding decrease in our income before income tax under Korean GAAP, in 2005.

Furthermore, in the second half of 2006, the Financial Supervisory Commission increased the minimum required provisioning levels applicable to loans, confirmed and unconfirmed acceptances and guarantees, bills endorsed and unused credit lines that are classified as normal and precautionary. The Financial Supervisory Commission also extended the requirement to establish other allowances on unused credit lines to cover inactive credit card accounts. These changes resulted in a significant increase in our allowance for loan losses, allowance for acceptances and guarantees and other allowances under Korean GAAP, and a corresponding decrease in our income before income tax under Korean GAAP, in 2006.

In addition, in November 2004, the Financial Supervisory Commission announced that it will implement new loan loss provisioning guidelines by the end of 2007 under which Korean banks will take into account “expected losses” with respect to credits in establishing their allowance for loan losses, instead of establishing such allowances based on the classification of credits under the current asset classification criteria. Under the new guidelines, all Korean banks were advised to establish systems to calculate their “expected losses” based on their historical losses during 2005. The Financial Supervisory Commission also announced that Korean banks could voluntarily comply with the new loan loss provisioning guidelines commencing in 2005. Specifically, in the second half of 2005, banks that had implemented a credible internal system for evaluating “expected losses” could establish their allowance for loan losses based on their historical losses, so long as the total allowance for loan losses established exceeded the levels required under the asset classification-based provisioning guidelines. Similarly, in the first half of 2006, banks that had implemented a credible system for evaluating “expected losses” could establish their allowance for loan losses based on such expected losses, so long as the total allowance established exceeded required levels. We complied with the new guidelines and implemented a system for evaluating “expected losses” in establishing our allowance for loan losses. However, the Financial Supervisory Commission has not since released any further details regarding the new guidelines, and it is unclear whether such new guidelines will be implemented at the end of 2007 as previously announced. Full compliance with the new guidelines may increase our provisions for loan losses under Korean GAAP compared to previous levels established under the asset classification-based provisioning guidelines.

Any future required increases in our provisions for loan losses under Korean GAAP could have an adverse effect on our reported results of operations and financial condition under Korean GAAP and our reported capital adequacy ratio, which in turn may adversely affect the market price of our common stock and ADSs.

 

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Government regulation of retail lending, particularly mortgage and home equity lending, has recently become more stringent, which may adversely affect our retail banking operations.

In light of concerns regarding the potential risks of excessive retail lending, particularly mortgage and home equity lending, the Korean government has in recent years adopted more stringent regulations with respect to retail lending by Korean banks. For example, in October 2003, the government advised Korean banks to limit their loans to a maximum of 40% of the value of the underlying real estate collateral, in the case of mortgage and home equity lending in areas where the average real estate price had increased substantially. In addition, the Korean government announced the implementation of measures to stabilize the real estate market in October 2003, which included:

 

   

building more residential apartments and houses;

 

   

enforcing more stringent supervision of property speculation; and

 

   

increasing the tax burden of those taxpayers who own real estate in excess of prescribed amounts.

The Korean government has also expressed a continuing commitment to stabilize the real estate market and willingness to implement additional measures, as necessary. For example, in 2004, 2005 and 2006, the Korean government has:

 

   

raised the residential property tax applicable to residential properties in cases where such property represents the third or more residential property owned by a single individual;

 

   

placed a ceiling on the sale price of newly constructed residential properties and, under certain circumstances, required developers to disclose the costs incurred in connection with the construction of such properties;

 

   

amended the Urban and Residential Environment Improvement Act to require that at least 25% of any increased floor space resulting from the redevelopment of existing residential properties be devoted to the construction of rental residential properties;

 

   

adopted more stringent guidelines that require financial institutions to impose debt-to-income ratio limits on customers, in addition to loan-to-value ratio requirements, in connection with mortgage loans for real estate located in areas of wide-spread real property speculation or excessive investment;

 

   

issued unofficial guidance recommending that Korean banks further limit their mortgage and home equity lending; and

 

   

adopted new measures to increase the supply of residential properties, including long-term residential lease properties.

See “Item 4B. Business Overview—Supervision and Regulation—Principal Regulations Applicable to Banks—Recent Regulations Relating to Retail Household Loans.”

These regulations and measures, as well as any similar regulations that the Korean government may adopt in the future, may have the effect of constraining the growth and profitability of our retail banking operations, especially in the area of mortgage and home equity lending. Furthermore, these regulations and measures may result in substantial future declines in real estate prices in Korea, which will reduce the value of the collateral securing our mortgage and home equity lending. See “—Other risks relating to our business—A decline in the value of the collateral securing our loans and our inability to realize full collateral value may adversely affect our credit portfolio.”

Government regulation of the credit card business has increased significantly in recent years, which may hurt our credit card operations.

Due to the rapid growth of the credit card market and rising consumer debt levels in Korea in prior years, the Korean government has heightened its regulatory oversight of the credit card industry. From mid-2002

 

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through early 2003, the Ministry of Finance and Economy and the Financial Supervisory Commission adopted a variety of amendments to existing regulations governing the credit card industry. Among other things, these amendments increased minimum required provisioning levels applicable to credit card receivables, required the reduction in volumes for certain types of credit card loans, increased minimum capital ratios and allowed the imposition of new sanctions against credit card companies that failed to meet applicable requirements. The Financial Supervisory Commission and the Financial Supervisory Service also implemented a number of changes to the rules governing the evaluation and reporting of credit card balances and delinquency ratios, as well as procedures governing which persons may receive credit cards. For more details relating to these regulations, see “Item 4B. Business Overview—Supervision and Regulation—Principal Regulations Applicable to Banks—Credit Card Business.”

The Korean government may adopt further regulatory changes in the future that affect the credit card industry. Depending on their nature, such changes may adversely affect our credit card operations, by restricting its growth or scope, subjecting it to stricter requirements and potential sanctions or greater competition, constraining its profitability or otherwise.

The fee income that we receive from the Korean government for acting as one of the managers of the National Housing Fund may be reduced if the Korean government designates additional financial institutions as managers or changes the basis of calculating fund management fees.

The National Housing Fund is a government fund that provides housing loans to low-income households and construction loans to fund projects to build small-sized housing. From 1981 until 2001, H&CB solely managed the operations of the National Housing Fund and received a monthly management fee. We have managed the fund since our formation as a result of the merger between the former Kookmin Bank and H&CB. In 2006, we received total management fees of (Won)172 billion.

In January 2000, the relevant law that had specified H&CB as the institution that manages the National Housing Fund was amended to provide that the Ministry of Construction and Transportation is to designate the institution that will perform this function. In November 2002, the ministry designated two other financial institutions as managers, together with us, of the National Housing Fund with a view to diversifying its management. In February 2003, the ministry changed the basis of calculating fees related to the National Housing Fund and, in March 2006, appointed an independent consultant to advise on further changes to the basis of calculating such fees and the designation of institutions to manage the National Housing Fund. If any future changes to the basis of calculating fees results in lower management fees or if the ministry decides to designate additional institutions to manage the National Housing Fund, our fee income from managing it will be reduced compared to current levels, which in turn may have an adverse effect on our results of operations.

Furthermore, in November 2003, the Ministry of Construction and Transportation strengthened existing regulations to provide for liability of managers of the National Housing Fund, where they have clear responsibility for non-performing National Housing Fund loans or where losses result due to their negligent management. As a result, we may in the future be required to reimburse the National Housing Fund for its losses, including those that relate to the deterioration of the credit quality of its loans, to the extent such losses are deemed to have resulted from our negligence in managing the fund.

The Korean government from time to time provides policy loans, which we may choose to accept, and may announce policies involving the participation of financial institutions, including us, in providing financial support for particular sectors.

The Korean government has in the past provided and may continue to provide policy loans, which encourage lending to particular types of borrowers. It has generally done this by identifying sectors of the economy it wishes to promote and making low-interest funding available to financial institutions that may voluntarily choose to lend to these sectors. The government has in this manner provided policy loans intended to

 

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promote mortgage lending to low-income individuals and lending to small- and medium-sized enterprises. All loans or credits we choose to make pursuant to these policy loans would be subject to review in accordance with our credit approval procedures. However, the availability of policy loans may influence us to lend to certain sectors or in a manner in which we otherwise would not in the absence of such loans from the government.

In the past, the Korean government has also announced policies under which financial institutions in Korea may voluntarily choose to provide financial support to particular sectors, including remedial programs for troubled corporate borrowers. For example, in light of the financial market instability in Korea resulting from the liquidity problems faced by credit card companies during the first quarter of 2003, the Korean government announced temporary measures in April 2003 intended to provide liquidity support to credit card companies. These measures included, among other things, requesting banks and other financial institutions to agree to extend the maturity of debt securities of credit card companies that they held and to make contributions to mutual funds to enable them to purchase debt securities of credit card companies.

The Korean government may in the future request financial institutions in Korea, including us, to make investments in or provide other forms of financial support to particular sectors of the Korean economy as a matter of policy, which financial institutions, including us, may decide to accept. We may incur costs or losses as a result of providing such financial support.

The Korean government is seeking to enact the proposed Financial Investment Services and Capital Market Act, which may intensify competition in the Korean banking industry.

Since 2006, the Korean government has been seeking to adopt a new law relating to the integration and rationalization of the Korean capital markets and financial investment products industry. The proposed law, which is named the Financial Investment Services and Capital Market Act, is expected to be adopted in 2008. If the law is adopted in its proposed form, we and other banks in Korea may face greater competition in the Korean financial services market from securities companies and other non-bank financial institutions. For example, securities companies currently are not permitted to accept deposits other than for purposes of securities investment by customers and may not provide secondary services in connection with securities investments such as settlement and remittance relating to such deposits. However, under the proposed new law, financial investment companies, which will replace the current securities companies, among others, will be able to provide such secondary services. Accordingly, we and other banks in Korea may experience a loss of customer deposits (which in turn may result in a need to seek alternative funding sources and an increase in our funding costs), as well as a decrease in our settlement and remittance service fee income.

Risks relating to Korea

Escalations in tensions with North Korea could have an adverse effect on us and the market price of our ADSs.

Relations between Korea and North Korea have been tense throughout Korea’s modern history. The level of tension between the two Koreas has fluctuated and may increase abruptly as a result of current and future events. In recent years, there have been heightened security concerns stemming from North Korea’s nuclear weapon and long-range missile programs and increased uncertainty regarding North Korea’s actions and possible responses from the international community. In December 2002, North Korea removed the seals and surveillance equipment from its Yongbyon nuclear power plant and evicted inspectors from the United Nations International Atomic Energy Agency. In January 2003, North Korea renounced its obligations under the Nuclear Non-Proliferation Treaty. Since the renouncement, Korea, the United States, North Korea, China, Japan and Russia have held numerous rounds of six party multi-lateral talks in an effort to resolve issues relating to North Korea’s nuclear weapons program.

 

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In addition to conducting test flights of long-range missiles, North Korea announced in October 2006 that it had successfully conducted a nuclear test, which increased tensions in the region and elicited strong objections worldwide. In response, the United Nations Security Council passed a resolution that prohibits any United Nations member state from conducting transactions with North Korea in connection with any large scale arms and material or technology related to missile development or weapons of mass destruction and from providing luxury goods to North Korea, imposes an asset freeze and travel ban on persons associated with North Korea’s weapons program, and calls upon all United Nations member states to take cooperative action, including through inspection of cargo to or from North Korea. In response, North Korea agreed in February 2007 at the six-party talks to shut down and seal the Yongbyon nuclear facility, including the reprocessing facility, and readmit international inspectors to conduct all necessary monitoring and verifications. In return, the other five parties in the six-party talks agreed to provide 50,000 tons of heavy fuel oil to North Korea in the initial phase of their energy assistance.

There can be no assurance that the February 2007 accord will be implemented as agreed or that the level of tension on the Korean peninsula will not escalate in the future. Any further increase in tension, including a breakdown of high-level contacts between Korea and North Korea or occurrence of military hostilities, could have a material adverse effect on our operations and the market value of our common stock and ADSs.

Unfavorable financial and economic developments in Korea may have an adverse effect on us.

We are incorporated in Korea, and substantially all of our operations are located in Korea. As a result, we are subject to political, economic, legal and regulatory risks specific to Korea. From early 1997 until 1999, Korea experienced a significant financial and economic downturn, from which the country took several years to recover.

The economic indicators in 2004, 2005 and 2006 have shown mixed signs of recovery and uncertainty, and future recovery or growth of the economy is subject to many factors beyond our control. Recent developments in the Middle East, including the war in Iraq and its aftermath, higher oil prices, the general weakness of the global economy and the possibility of an outbreak of avian flu in Asia and other parts of the world have increased the uncertainty of global economic prospects in general and may continue to adversely affect the Korean economy for some time. Any future deterioration of the Korean or global economy could adversely affect our financial condition and results of operations.

Developments that could hurt Korea’s economy in the future include:

 

   

financial problems relating to chaebols, or their suppliers, and their potential adverse impact on the Korean economy;

 

   

failure or lack of progress in restructuring of chaebols, the financial industry and other large troubled companies;

 

   

loss of investor confidence arising from corporate accounting irregularities and corporate governance issues at certain chaebols;

 

   

a slowdown in consumer spending and the overall economy;

 

   

increasing delinquencies and credit defaults by retail and small- and medium-sized enterprise borrowers;

 

   

adverse changes or volatility in foreign currency reserve levels, commodity prices (including a further increase in oil prices), exchange rates (including fluctuation of the U.S. dollar or Japanese yen exchange rates or revaluation of the Chinese renminbi), interest rates and stock markets;

 

   

increased reliance on exports to service foreign currency debts, which could cause friction with Korea’s trading partners;

 

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adverse developments in the economies of countries that are important export markets for Korea, such as the United States, Japan and China, or in emerging market economies in Asia or elsewhere that could result in a loss of confidence in the Korean economy;

 

   

the continued emergence of China, to the extent its benefits (such as increased exports to China) are outweighed by its costs (such as competition in export markets or for foreign investment and the relocation of the manufacturing base from Korea to China);

 

   

social and labor unrest;

 

   

a decrease in tax revenues and a substantial increase in the Korean government’s expenditures for unemployment compensation and other social programs that, together, would lead to an increased government budget deficit;

 

   

geo-political uncertainty and risk of further attacks by terrorist groups around the world;

 

   

the recurrence of SARS or an outbreak of avian flu in Asia and other parts of the world;

 

   

deterioration in economic or diplomatic relations between Korea and its trading partners or allies, including such deterioration resulting from trade disputes or disagreements in foreign policy;

 

   

political uncertainty or increasing strife among or within political parties in Korea;

 

   

hostilities involving oil producing countries in the Middle East and any material disruption in the supply of oil or increase in the price of oil resulting from those hostilities; and

 

   

an increase in the level of tensions or an outbreak of hostilities between North Korea and Korea and/or the United States.

Ongoing significant reforms and changes to the regulatory framework for the Korean financial industry could adversely affect our results of operations.

The legal and regulatory framework for the Korean financial industry is undergoing significant reforms and changes. For example, in the past the Korean government regulated, among other things, lending rates and deposit rates for banks. Regulations also dictated the extent of competition by restricting new entrants and the growth of existing financial institutions, including the opening of new branches. Ongoing regulatory reforms have removed all controls on lending rates and deposit rates (except for the prohibition on interest payments on current account deposits) and have relaxed barriers to entry, including by foreign financial institutions, leading to increased competition. Further liberalization of the financial services industry in Korea could result from the conclusion of a free trade agreement between Korea and the United States in 2007. At the same time, the Korean government has revised its regulations in recent years to impose stricter regulatory standards and oversight on Korean financial institutions, as part of its efforts to modernize the industry and to address specific social and economic issues. In particular, the Korean government has revised the regulations relating to credit cards and household lending as part of its effort to control the potential risks of excessive consumer lending. Continuing regulatory changes in the financial industry will require us to modify our business operations and may adversely affect our results of operations.

Labor unrest in Korea may adversely affect our operations.

Any future economic downturn in Korea or an increase in corporate reorganizations and bankruptcies could result in layoffs and higher unemployment. Such developments could lead to social unrest and substantially increase government expenditures for unemployment compensation and other costs for social programs. According to statistics from the Korea National Statistics Office, the unemployment rate increased from 3.3% in 2002 to 3.6% in 2003 and 3.7% in 2004 and 2005. Although the unemployment rate decreased slightly to 3.5% in 2006, an increase in unemployment and any resulting labor unrest in the future could adversely affect our operations, as well as the operations of many of our customers and their ability to repay their loans, and could

 

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adversely affect the financial condition of Korean companies in general, depressing the price of their securities. These developments would likely have an adverse effect on our financial condition and results of operations.

Financial instability in other countries, particularly emerging market countries in Asia, could adversely impact our business and cause the price of the ADSs to go down.

The Korean market and the Korean economy are influenced by economic and market conditions in other countries, particularly emerging market countries in Asia, including China. Financial turmoil in Asia, Russia and elsewhere in the world in recent years has adversely affected the Korean economy. Although economic conditions are different in each country, investors’ reactions to developments in one country can have adverse effects on the securities of companies in other countries, including Korea. A loss of investor confidence in the financial systems of emerging and other markets may cause increased volatility in Korean financial markets. Furthermore, in December 2003, we invested approximately 121 million Singapore dollars for an approximately 25% interest in Sorak Financial Holdings, which acquired an approximately 57% interest in Bank Internasional Indonesia, and we may make similar investments outside Korea in the future. We cannot be certain that financial events of the type that occurred in emerging markets in Asia in 1997 and 1998 will not happen again in Asia or in other markets in which we may invest, or that such events will not have an adverse effect on our business or the price of our common stock and ADSs.

Risks relating to our common stock and ADSs

Ownership of our common stock is restricted under Korean law.

Under Korean law, a single stockholder, together with its affiliates, is generally prohibited from owning more than 10.0% of the outstanding shares of voting stock of a nationwide bank such as us, with the exception of certain stockholders that are non-financial group companies, whose applicable limit is 4.0%. The Korean government, the Korea Deposit Insurance Corporation and bank holding companies are exempt from this limit, and investors may also exceed the 10.0% limit upon filing a report with, or approval by, the Financial Supervisory Commission. See “Item 4B. Business Overview—Supervision and Regulation—Principal Regulations Applicable to Banks—Restrictions on Bank Ownership.” To the extent that the total number of shares of our common stock (including those represented by ADSs) that a holder and its affiliates own together exceeds that limit, that holder will not be entitled to exercise the voting rights for the excess shares, and the Financial Supervisory Commission may order that holder to dispose of the excess shares within a period of up to six months. Failure to comply with such an order would result in an administrative fine of up to 0.03% of the book value of such shares per day until the date of disposal.

A holder of our ADSs may not be able to exercise dissent and appraisal rights unless it has withdrawn the underlying shares of our common stock and become our direct stockholder.

In some limited circumstances, including the transfer of the whole or any significant part of our business and the merger or consolidation of us with another company, dissenting stockholders have the right to require us to purchase their shares under Korean law. However, holders of our ADSs will not be able to exercise such dissent and appraisal rights if the depositary refuses to do so on their behalf. Our deposit agreement does not require the depositary to take any action in respect of exercising dissent and appraisal rights. In such a situation, holders of our ADSs must withdraw the underlying common stock from the ADS facility (and incur charges relating to that withdrawal) and become our direct stockholder prior to the record date of the stockholders’ meeting at which the relevant transaction is to be approved, in order to exercise dissent and appraisal rights.

A holder of our ADSs may be limited in its ability to deposit or withdraw common stock.

Under the terms of our deposit agreement, holders of common stock may deposit such stock with the depositary’s custodian in Korea and obtain ADSs, and holders of ADSs may surrender ADSs to the depositary

 

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and receive common stock. However, to the extent that a deposit of common stock exceeds the difference between:

 

  (1) the aggregate number of common shares we have deposited or we have consented to allow to be deposited for the issuance of ADSs (including deposits in connection with offerings of ADSs and stock dividends or other distributions relating to ADSs); and

 

  (2) the number of shares of common stock on deposit with the custodian for the benefit of the depositary at the time of such proposed deposit,

such common stock will not be accepted for deposit unless

 

  (A) our consent with respect to such deposit has been obtained; or

 

  (B) such consent is no longer required under Korean laws and regulations.

Under the terms of the deposit agreement, no consent is required if the shares of common stock are obtained through a dividend, free distribution, rights offering or reclassification of such stock. We have consented, under the terms of the deposit agreement, to any deposit to the extent that, after the deposit, the number of deposited shares does not exceed 115,840,996 shares or any other number of shares we determine from time to time, unless the deposit would be prohibited by applicable laws or violate our articles of incorporation. We might not consent to the deposit of any additional common stock. As a result, if a holder surrenders ADSs and withdraws common stock, it may not be able to deposit the stock again to obtain ADSs.

A holder of our ADSs will not have preemptive rights in some circumstances.

The Korean Commercial Code of 1962, as amended, and our articles of incorporation require us, with some exceptions, to offer stockholders the right to subscribe for new shares of our common stock in proportion to their existing shareholding ratio whenever new shares are issued. If we offer any rights to subscribe for additional shares of our common stock or any rights of any other nature, the depositary, after consultation with us, may make the rights available to holders of our ADSs or use reasonable efforts to dispose of the rights on behalf of such holders and make the net proceeds available to such holders. The depositary, however, is not required to make available to holders any rights to purchase any additional shares of our common stock unless it deems that doing so is lawful and feasible and:

 

   

a registration statement filed by us under the U.S. Securities Act of 1933, as amended, is in effect with respect to those shares; or

 

   

the offering and sale of those shares is exempt from or is not subject to the registration requirements of the Securities Act.

Similarly, holders of our common stock located in the United States may not exercise any such rights they receive absent registration or an exemption from the registration requirements under the Securities Act.

We are under no obligation to file any registration statement with the U.S. Securities and Exchange Commission or to endeavor to cause such a registration statement to be declared effective. Moreover, we may not be able to establish an exemption from registration under the Securities Act. Accordingly, a holder of our ADSs may be unable to participate in our rights offerings and may experience dilution in its holdings. If a registration statement is required for a holder of our ADSs to exercise preemptive rights but is not filed by us or is not declared effective, the holder will not be able to exercise its preemptive rights for additional ADSs and it will suffer dilution of its equity interest in us. If the depositary is unable to sell rights that are not exercised or not distributed or if the sale is not lawful or feasible, it will allow the rights to lapse, in which case the holder will receive no value for these rights.

 

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Dividend payments and the amount a holder of our ADSs may realize upon a sale of its ADSs will be affected by fluctuations in the exchange rate between the U.S. dollar and the Won.

Our common stock is listed on the Stock Market Division of the Korea Exchange and quoted and traded in Won. Cash dividends, if any, in respect of the shares represented by the ADSs will be paid to the depositary in Won and then converted by the depositary into U.S. dollars, subject to certain conditions. Accordingly, fluctuations in the exchange rate between the Won and the U.S. dollar will affect, among other things, the amounts a holder of our ADSs will receive from the depositary in respect of dividends, the U.S. dollar value of the proceeds that it would receive upon sale in Korea of the shares of our common stock obtained upon surrender of ADSs and the secondary market price of ADSs. Such fluctuations will also affect the U.S. dollar value of dividends and sales proceeds received by holders of our common stock.

The market value of an investment in our ADSs may fluctuate due to the volatility of the Korean securities market.

Our common stock is listed on the Stock Market Division of the Korea Exchange, which has a smaller market capitalization and is more volatile than the securities markets in the United States and many European countries. The market value of ADSs may fluctuate in response to the fluctuation of the trading price of shares of our common stock on the Stock Market Division of the Korea Exchange. The Stock Market Division of the Korea Exchange has experienced substantial fluctuations in the prices and volumes of sales of listed securities and the Stock Market Division of the Korea Exchange has prescribed a fixed range in which share prices are permitted to move on a daily basis. In the 1990’s, the Korea Composite Stock Price Index, known as the “KOSPI,” reached a peak for the decade of 1,138.75 in 1994 and subsequently fell to a low of 280.00 in 1998. On April 17, 2000, the KOSPI experienced a 93.17 point drop, which represented the single largest decrease in the history of the KOSPI. On June 27, 2007, the KOSPI closed at 1,733.10. Like other securities markets, including those in developed markets, the Korean securities market has experienced problems including market manipulation, insider trading and settlement failures. The recurrence of these or similar problems could have a material adverse effect on the market price and liquidity of the securities of Korean companies, including our common stock and ADSs, in both the domestic and the international markets.

The Korean government has the potential ability to exert substantial influence over many aspects of the private sector business community, and in the past has exerted that influence from time to time. For example, the Korean government has promoted mergers to reduce what it considers excess capacity in a particular industry and has also encouraged private companies to publicly offer their securities. Similar actions in the future could have the effect of depressing or boosting the Korean securities market, whether or not intended to do so. Accordingly, actions by the government, or the perception that such actions are taking place, may take place or has ceased, may cause sudden movements in the market prices of the securities of Korean companies in the future, which may affect the market price and liquidity of our common stock and ADSs.

If the Korean government deems that emergency circumstances are likely to occur, it may restrict holders of our ADSs and the depositary from converting and remitting dividends and other amounts in U.S. dollars.

If the Korean government deems that certain emergency circumstances, including, but not limited to, severe and sudden changes in domestic or overseas economic circumstances, extreme difficulty in stabilizing the balance of payments or implementing currency exchange rate and other macroeconomic policies, have occurred or are likely to occur, it may impose certain restrictions provided for under the Foreign Exchange Transaction Law, including the suspension of payments or requiring prior approval from governmental authorities for any transaction. See “Item 10D. Exchange Controls—General.”

Other Risks

A holder of our ADSs may not be able to enforce a judgment of a foreign court against us.

We are a corporation with limited liability organized under the laws of Korea. Substantially all of our directors and officers and other persons named in this document reside in Korea, and all or a significant portion

 

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of the assets of our directors and officers and other persons named in this document and substantially all of our assets are located in Korea. As a result, it may not be possible for holders of our ADSs to effect service of process within the United States, or to enforce against them or us in the United States judgments obtained in United States courts based on the civil liability provisions of the federal securities laws of the United States. There is doubt as to the enforceability in Korea, either in original actions or in actions for enforcement of judgments of United States courts, of civil liabilities predicated on the United States federal securities laws.

 

Item 4. INFORMATION ON THE COMPANY

 

Item 4A. History and Development of the Company

Our legal and commercial name is Kookmin Bank. Our registered office and principal executive offices are located at 9-1, 2-ga, Namdaemoon-ro, Jung-gu, Seoul, Korea 100-703. Our telephone number is 822-2073-8341. Our agent in the United States, Kookmin Bank, New York Branch, is located at 565 Fifth Avenue, 24th Floor, New York, NY 10017. Its telephone number is (212) 697-6100.

History of the Former Kookmin Bank

The former Kookmin Bank was established by the Korean government in 1963 under its original name of Citizens National Bank under the Citizens National Bank Act of Korea with majority government ownership. Under this Act, we were limited to providing banking services to the general public and to small- and medium-sized enterprises. See “Item 4B. Business Overview—Corporate Banking—Small- and Medium-sized Enterprise Banking” for an exact definition of small- and medium-sized enterprises. In September 1994, we completed our initial public offering in Korea and listed our shares on the Stock Market Division of the Korea Exchange.

In January 1995, the Citizens National Bank Act of Korea was repealed and replaced by the Repeal Act of the Citizens National Bank Act. Our status was changed from a specialized bank to a nationwide commercial bank and in February 1995, we changed our name to Kookmin Bank. The Repeal Act allowed us to engage in lending to large businesses. Following the repeal, however, under our articles of incorporation at that time, only up to 20% of our total Won-currency loans outstanding was allowed to be made to large businesses. Currently, under our articles of incorporation, financial services to individuals and small- and medium-sized enterprises (including mortgage lending) are required to be equal to or more than 60% of the total amount of our loans denominated in Won.

In June 1998, we acquired certain assets, including loans the majority of which were considered performing as of the purchase date, and assumed most of the liabilities of DaeDong Bank, pursuant to a directive from the Financial Supervisory Commission in connection with a government program to support the deteriorating financial sector in Korea. We assumed 519 out of 1,740 employees and 49 out of 108 branches of DaeDong Bank. As of the date of the acquisition, there was a net shortfall of (Won)1,687 billion between the value of the assets we acquired and the value of the liabilities we assumed. We received cash and debt securities issued by the Korea Deposit Insurance Corporation and the Korea Asset Management Corporation in connection with the acquisition.

In December 1998, we merged with the Korea Long Term Credit Bank, which focused on providing large corporate banking services. Through this acquisition, we were able to selectively expand our large corporate business, while continuing to concentrate on the retail sector. This expansion resulted in increased product and service offerings, including wholesale deposits, corporate overdraft facilities, bills and receivables discounting, export/import financing, payment remittances, foreign exchange transactions, standby letters of credit and guarantees and acceptances.

In June 1999, Goldman Sachs Capital Koryo, L.P., a fund managed by The Goldman Sachs Group, Inc., acquired (through its wholly owned subsidiaries Goldman Sachs Capital Chosun, Ltd. and Goldman Sachs Capital Shilla, Ltd.) an interest in the former Kookmin Bank as a result of an investment of US$500 million in new

 

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common shares and convertible bonds, consisting of (Won)360 billion of new common shares (17,768,870 common shares at (Won)20,260 per share, as adjusted for the merger ratio of 1.688346:1) and US$200 million principal amount of subordinated convertible bonds with an original conversion price of (Won)14,200 per common share. Goldman Sachs Capital Koryo subsequently sold substantially all of the shares of our common stock it owned (including common stock obtained upon conversion of the convertible bonds) in June 2002 and November 2003.

History of H&CB

H&CB was established by the Korean government in 1967 under the name Korea Housing Finance Corporation. In 1969, Korea Housing Finance Corporation became the Korea Housing Bank pursuant to the Korea Housing Bank Act. H&CB was originally established to provide low and middle income households with long-term, low-interest mortgages in order to help them purchase their own homes, and to promote the increase of housing supply in Korea by providing low-interest housing loans to construction companies. Under the Korea Housing Bank Act, up to 20% of H&CB’s lending (excluding lending pursuant to government programs) could be non-mortgage lending. Until 1997 when the Korea Housing Bank Act was repealed, H&CB was the only entity in Korea allowed to provide mortgage loans with a term of longer than ten years. H&CB also had the exclusive ability to offer housing-related deposit accounts offering preferential rights to subscribe for newly-built apartments.

In June 1998, H&CB acquired certain assets, including loans the majority of which were considered performing as of the purchase date, and assumed most of the liabilities of DongNam Bank, pursuant to a directive from the Financial Supervisory Commission in connection with a government program to support the deteriorating financial sector in Korea. H&CB assumed 650 out of 1,661 employees and 49 out of 116 branches of DongNam Bank. As of the date of the DongNam Bank acquisition, there was a net shortfall of (Won)1,453 billion between the value of the assets it acquired and the value of the liabilities it assumed. As in the case of the former Kookmin Bank, H&CB received cash and debt securities issued by the Korea Deposit Insurance Corporation and the Korea Asset Management Corporation in connection with the acquisition. The acquisition of DongNam Bank strengthened H&CB’s business presence in the southeastern region of Korea where DongNam Bank was based.

In July 1999, H&CB entered into an investment agreement with certain affiliates of the ING Groep N.V., a leading global financial services group. Through ING Insurance International B.V. and ING International Financial Holdings, ING Groep N.V. invested (Won)332 billion to acquire 9,914,777 new common shares of H&CB representing 9.99999% of H&CB’s outstanding common shares. As of December 31, 2006, ING Groep N.V. beneficially owned 4.06% of our outstanding common stock.

In December 2002, we formally extended our strategic alliance agreement with ING Bank N.V., replacing its prior investment agreement with H&CB. In August 2003, our board approved and ratified an amended and restated strategic alliance agreement with ING Bank N.V. As a result:

 

   

the exclusive alliance with respect to our bancassurance business was revised to a non-exclusive, commercial relationship-based alliance;

 

   

ING Groep N.V. is required to maintain beneficial ownership of no less than 12,716,691 shares of our common stock, subject to adjustment for any share consolidations or share splits or, in the event of a merger with another entity, as adjusted accordingly pursuant to the merger ratio for the merger; and

 

   

each party agreed to maintain its level of investment in ING Life Insurance Company, Korea Ltd. (which is currently 20% owned by us and 80% owned by ING Insurance International B.V.) and KB Asset Management Co., Ltd. (which is currently 80% owned by us and 20% by ING Insurance International B.V.) until August 29, 2006.

For more details regarding our relationship with ING Groep N.V., see “Item 4B. Business Overview—Other Businesses—Bancassurance,” “Item 7B. Related Party Transactions” and “Item 10C. Material Contracts.”

 

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The Merger of the Former Kookmin Bank and H&CB

In November 2000, the former Kookmin Bank and H&CB entered into discussions regarding a possible merger. On December 22, 2000, the two banks entered into a memorandum of understanding regarding the merger. The proposed merger was publicly announced in Korea on that date. On April 23, 2001, the two banks executed a merger agreement approved by their respective boards of directors. The merger was structured as a merger of the two banks into a new entity in order to ensure that the transaction was properly understood by the security holders and customers of the two banks, as well as their employees, as a merger of equals rather than an absorption by one bank of the other. Under U.S. GAAP, however, the former Kookmin Bank was deemed the accounting acquiror of H&CB in the merger. We accounted for the acquisition using the purchase method of accounting.

On September 29, 2001, the merger proposal was approved by the stockholders of both banks at extraordinary general meetings called for that purpose. The merger became effective on November 1, 2001. This merger resulted in Kookmin Bank becoming the largest commercial bank in Korea. Our ADSs were listed on the New York Stock Exchange on November 1, 2001 and our common shares were listed on the Stock Market Division of the Korea Exchange on November 9, 2001. As of October 31, 2001, H&CB’s total assets were (Won)67,399 billion, its total deposits were (Won)51,456 billion, its total liabilities were (Won)64,537 billion and it had stockholders’ equity of (Won)2,849 billion. As required by U.S. GAAP, we recognized H&CB’s total assets and liabilities at their estimated fair values of (Won)68,329 billion and (Won)64,840 billion, respectively. These amounts reflect the recognition of (Won)562 billion of negative goodwill, which was allocated to the fixed assets, core deposit intangible assets and credit card relationship intangible assets assumed.

At the time of the merger, we issued 179,775,233 shares of our common stock to holders of former Kookmin Bank shares and 119,922,229 shares of our common stock to holders of former H&CB shares. The merger ratio was such that holders of former Kookmin Bank common stock received one of our shares for every 1.688346 shares of former Kookmin Bank they owned, and holders of H&CB common stock received one of our shares for every share of H&CB common stock they owned.

In December 2003, the Korean government sold all of our common stock it held to us, through an auction process in which we were chosen as the winning bidder. We subsequently sold all of these shares in an over-the-counter transaction in June 2005.

The Merger with Kookmin Credit Card

On May 30, 2003, we entered into a merger agreement with Kookmin Credit Card, previously a 75% owned and consolidated subsidiary. On July 23, 2003, our board approved the merger with Kookmin Credit Card and on September 5, 2003, the merger was approved by the shareholders of Kookmin Credit Card. On September 30, 2003, we merged with Kookmin Credit Card.

The merger was effected by the issuance of 8,120,431 shares of our common stock, and the former minority shareholders of Kookmin Credit Card received 0.442983 shares of our common stock for every one share of Kookmin Credit Card common stock that they owned and cash instead of fractional shares that they would have otherwise been entitled to receive in the merger. Immediately following the merger, former shareholders of Kookmin Credit Card common stock, other than us, owned approximately 2.4% of our outstanding common stock. The acquisition of minority interest was accounted for under the purchase method of accounting, and we stepped up the assets and liabilities acquired to their fair values at the date of acquisition. The excess of fair value of purchase consideration over the fair value of net assets acquired was recognized as goodwill.

The goals of this merger were to:

 

   

alleviate the difficulties that Kookmin Credit Card was experiencing with respect to its liquidity and capital adequacy;

 

   

maximize management efficiency and further enhance our credit card business;

 

   

assist us in developing a leading credit card business in Korea;

 

   

enable us to effectively cross-sell our financial products by integrating our database; and

 

   

develop and launch products and services that integrated our credit card and banking businesses.

 

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Item 4B. Business Overview

Business

We are the largest commercial bank in Korea. As of December 31, 2006, we had total assets of (Won)192,978 billion and total deposits of (Won)129,540 billion. On the asset side, we provide credit and related financial services to individuals and small- and medium-sized enterprises and, to a lesser extent, to large corporate customers. On the deposit side, we provide a full range of deposit products and related services to both individuals and enterprises of all sizes.

By their nature, our core consumer and small- and medium-sized enterprise operations place a high premium on customer access and convenience. Our combined network of 1,132 branches as of December 31, 2006, the most extensive in Korea, provides a solid foundation for our business and is a major source of our competitive strength. This network provides us with a large, stable and cost effective funding source, enables us to provide our customers convenient access and gives us the ability to provide the customer attention and service essential to conducting our business, particularly in an increasingly competitive environment. Our branch network is further enhanced by automated banking machines and fixed-line, mobile telephone and Internet banking. As of December 31, 2006, we had a customer base of over 25 million retail customers, which represented approximately one-half of the Korean population. Of the population in Korea between the ages of 20 and 40, approximately two-thirds have accounts with us. As of December 31, 2006, we also had over 125,000 small- and medium-sized enterprise customers.

The following table sets forth the principal components of our lending business as of the dates indicated. As of December 31, 2006 retail loans, credit card loans and credit card receivables accounted for 62.4% of our total loan portfolio:

 

     As of December 31,  
     2004     2005     2006  
     (in billions of Won, except percentages)  

Retail

               

Mortgage and home equity (1)

   (Won) 57,965    42.0 %   (Won) 59,143    42.9 %   (Won) 63,982    42.3 %

Other consumer (2)

     25,963    18.8       23,114    16.7       21,589    14.2  
                                       

Total retail

     83,928    60.8       82,257    59.6       85,571    56.5  

Credit card

     9,421    6.8       8,369    6.1       8,955    5.9  

Corporate

     43,657    31.6       46,157    33.4       56,096    37.1  

Capital markets activities and international banking

     1,118    0.8       1,229    0.9       781    0.5  
                                       

Total loans

   (Won) 138,124    100.0 %   (Won) 138,012    100.0 %   (Won) 151,403    100.0 %
                                       

(1)

Includes (Won)1,186 billion, (Won)1,174 billion and (Won)1,137 billion of overdraft loans secured by real estate in connection with home equity loans as of December 31, 2004, 2005 and 2006, respectively.

(2)

Includes (Won)9,062 billion, (Won)7,620 billion and (Won)7,481 billion of overdraft loans as of December 31, 2004, 2005 and 2006, respectively.

We provide a full range of personal lending products and retail banking services to individual customers, including mortgage loans. We are the largest private sector mortgage lender in Korea. We are also one of the managers of the National Housing Fund, a government fund that provides housing loans to low income households and loans to construction companies to build small-sized housing for low income households.

Lending to small- and medium-sized enterprises is the single largest component of our non-retail credit portfolio and represents a widely diversified exposure to a broad spectrum of the Korean corporate community, both by type of lending and type of customer, with one of the newest categories being collateralized loans to

 

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SOHO customers that are among the smallest of the small- and medium-sized enterprises. The volume of our loans to small- and medium-sized enterprises requires a customer-oriented approach that is facilitated by our large and geographically diverse branch network.

In keeping with industry trends, our credit exposure to large corporate customers is declining as a percentage of our total loan portfolio although we continue to maintain and to seek quality relationships and to expand them by providing these customers with an increasing range of fee-related services.

Since the former Kookmin Bank initiated the issuance of domestic credit cards in 1980, we have seen our credit card business grow rapidly, particularly in 2001 and 2002 as the nationwide trend towards credit card use accelerated. As of December 31, 2006, we had more than 9 million holders of KB Card.

Strategy

Our strategic focus is to be the leading bank in Korea and a world-class financial service provider. We plan to continue to develop our business on the basis of our core strengths in mortgage financing and retail banking. We believe our strong market position is an important competitive advantage, which will enable us to compete more effectively based on convenient delivery, product breadth and differentiation, and service quality while focusing on our profitability.

The key elements of our strategy are as follows:

Identifying, targeting and marketing to attractive customer segments and providing superior customer value and service to such segments

In recent years, rather than focusing on developing products and services to satisfy the overall needs of the general population, we have increasingly targeted specific market segments that we expect to generate superior growth and profitability. We will continue to implement a targeted marketing approach that seeks to identify the most attractive customer segments and to develop strategies to build market share in those segments. In particular, we intend to increase our “wallet share” of superior existing customers by using our advanced customer relationship management technology to better identify and meet the needs of our most creditworthy and high net worth customers, on whom we intend to concentrate our marketing efforts. We estimate that there are approximately 6 million people who fall into this category in Korea, and we aim to cross-sell our loan and other products to those customers who have an account with us.

As part of this strategy, we are also focusing on attracting and retaining creditworthy customers by offering more differentiated fee-based products and services that are tailored to meet their specific needs. The development and marketing of our products and services are, in part, driven by customer segmentation to ensure we meet the needs of each customer segment. For instance, we currently offer customized mortgage products and electronic banking promotions, and have enhanced our private banking services for high net worth individuals, including opening new branches specializing in such services. We also continue to develop more complex financial products, including trust commodities and other investment products, for which consumer demand has increased in recent years. We are also focusing on addressing the needs of our customers by providing the highest-quality products and services and developing an open-architecture strategy, which allows us to sell such products through the largest branch network in Korea. In short, we aim to offer our customers a convenient one-stop financial services destination where they can meet their traditional retail and corporate banking requirements, as well as find a broad array of fee-based products and services tailored to address more specific banking needs. We believe such differentiated, comprehensive services and cross-selling will not only enhance customer loyalty but also increase profitability.

 

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One of our key customer-related strategies continues to be creating greater value and better service for our customers. We intend to continue improving our customer service, including through:

 

   

Improved customer relationship management technology. Management has devoted substantial resources toward development of our customer relationship management system, which is designed to provide our employees with the needed information to continually improve the level of service and incentives offered to our preferred customers. Our system is based on an integrated customer database, which allows for better customer management and streamlines our customer reward system. We have also developed state-of-the-art call centers and online Internet capabilities to provide shorter response times to customers seeking information or to execute transactions. Our goals are to continually focus on improving customer service to satisfy our customer’s needs through continuing efforts to deliver new and improved services and to upgrade our customer relationship management system to provide the best possible service to our customers in the future.

 

   

Enhanced distribution channels. We also believe we can improve customer retention and usage rates by increasing the range of products and services we offer and by developing a differentiated, multi-channel distribution network, including branches, ATMs, call centers, mobile-banking and Internet banking. We believe that our leading market position gives us a competitive advantage in developing and enhancing our distribution capabilities.

Focusing on expanding and improving credit quality in our corporate lending business

We plan to focus on corporate lending as one of our core businesses through attracting top-tier corporate customers and providing customized and distinctive products and services to build our position as a leading bank in the corporate financial market. To increase our market share in providing financial services to the corporate market, we intend to:

 

   

promote a more balanced and strengthened portfolio with respect to our corporate business by developing our large corporate customer base and utilizing our improved credit management operations to better evaluate new large corporate and small- and medium-sized enterprise customers;

 

   

develop and sell more varied corporate financial products, consisting of transactional banking products which provide higher margin and less risk such as “cyber branch” products to large corporate customers and “cyber CEO” products to small- and medium-sized enterprise customers;

 

   

generate more fee income from large corporate customers through business-to-business transactions, foreign exchange transactions and derivative and other investment products;

 

   

further develop and train our core professionals with respect to this market, including through programs such as the “career development path”;

 

   

strengthen our marketing system based on our accumulated expertise in order to attract top-tier corporate customers; and

 

   

focus on enhancing our channel network in order to provide the best service by strengthening our corporate customer management.

Strengthening internal risk management capabilities

We believe that ensuring strong asset quality through effective credit risk management is critical to maintaining stable growth and profitability and risk management will continue to be one of our key focus areas. One of our highest priorities is to improve our asset quality and more effectively price our lending products to take into account inherent credit risk in our portfolio. Our goal is to maintain the soundness of our credit portfolio, profitability and capital base. To this end, we intend to continue to strengthen our internal risk

 

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management capabilities by tightening our underwriting and management policies and improving our internal compliance policies. To accomplish this objective, we have undertaken the following initiatives:

 

   

Strengthening underwriting procedures with advanced credit scoring techniques. We have centralized our credit management operations into our credit group. Our prior structure had divided such operations into four groups and ten teams. As a result of such centralization, we aim to enhance our credit management expertise and improve our system of checks-and-balances with respect to our credit portfolio. We have also improved our ability to evaluate the credit of our small- and medium-sized enterprise customers through assigning experienced credit loan officers to our regional credit offices. We have also introduced a policy requiring the same officer to evaluate, review and monitor the outstanding loans and other credits with respect to a customer, which will enhance expertise and improve efficiency and accountability of such officer, while enabling us to maintain a consistent credit policy. We have also, as a general matter, implemented enhanced credit analysis and scoring techniques, which we believe will enable us to make better-informed decisions about the credit we extend and improve our ability to respond more quickly to incipient credit problems. We are also focusing on enhancing our asset quality through improvement of our early monitoring systems and collection procedures.

 

   

Improving our internal compliance policy and ensuring strict application in our daily operations. We have improved our monitoring capabilities with respect to our internal compliance and providing training and educational programs to our management and employees. We have also implemented strict compliance policies to maintain the integrity of our risk management system.

Cultivating a performance-based, customer-oriented culture that emphasizes market best practices

We believe a strong and dedicated workforce is critical to our ability to offer our customers the highest quality banking services and is integral to our goal of maintaining our position as one of Korea’s leading financial service providers. In the past, we have dedicated significant resources to develop and train our core professionals, and we intend to continue to enhance the productivity of our employees, including by regularly sponsoring in-house training and educational programs. We have also been seeking to cultivate a performance-based culture to create a work environment where members of our staff are incentivized to maximize their potential and in which our employees are directly rewarded for superior performance. We intend to maintain a professional workforce whose high quality of customer service reflects our goal to achieve and maintain global best practice standards in all areas of operations.

We plan to establish new mid- to long-term strategies to address changes in our operations and market conditions, including the pending implementation of the Financial Investment Services and Capital Market Act.

Branch Network

As of December 31, 2006, we had 1,132 branches and sub-branches in Korea, which were the largest number of branches among Korean commercial banks. In Korea, retail transactions are generally conducted in cash, although credit card use has increased, and conventional checking accounts are not offered or used as widely as in other countries. An extensive branch network is important to attracting and maintaining retail customers, who use branches extensively and value convenience. We believe that our extensive branch network in Korea and retail customer base provide us with a source of stable and relatively low cost funding. More than 40% of our branches and sub-branches are located in Seoul, and approximately 24% of our branches are located in the six next largest cities. The following table presents the geographical distribution of our branch network in Korea as of December 31, 2006:

 

Area

   Number of
branches
   Percentage  

Seoul

   458    40.5 %

Six largest cities (other than Seoul)

   266    23.5  

Other

   408    36.0  
           

Total

   1,132    100.0 %
           

 

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In addition, we have continued to implement the specialization of branch functions. Of our branch network, 96 branches handle corporate transactions exclusively and are dedicated to providing comprehensive services to our corporate customers.

In order to support our branch network, we have established an extensive network of automated banking machines, which are located in branches and in unmanned outlets known as “autobanks.” These automated banking machines consist of ATMs, cash dispensers and passbook printers. As of December 31, 2006, we had 8,930 ATMs, 161 cash dispensers and 381 passbook printers.

We have actively promoted the use of these distribution outlets in order to provide convenient service to customers, as well as to maximize the marketing and sales functions at the branch level, reduce employee costs and improve profitability. The following table sets forth information, for the periods indicated, regarding the number of transactions and the fee revenue of our ATMs, including those that only dispense cash:

 

     For the year ended
December 31,
     2004    2005    2006

Number of transactions (millions)

     786      621      675

Fee revenue (in billions of Won)

   (Won) 92    (Won) 90    (Won) 89

Retail Banking

Due to our development as a retail bank and the know-how and expertise we have acquired from our activities in that market, retail banking has been and will continue to remain one of our core businesses. Our retail banking activities consist primarily of lending and deposit-taking.

Lending Activities

We offer various loan products that target different segments of the population, with features tailored to each segment’s financial profile and other characteristics. The following table sets forth the balances and the percentage of our total lending represented by our retail loans as of the dates indicated:

 

     As of December 31,  
     2004     2005     2006  
     (in billions of Won, except percentages)  

Retail:

               

Mortgage and home equity loans

   (Won) 57,965    42.0 %   (Won) 59,143    42.9 %   (Won) 63,982    42.3 %

Other consumer loans (1)

     25,963    18.8       23,114    16.7       21,589    14.2  
                                       

Total

   (Won) 83,928    60.8 %   (Won) 82,257    59.6 %   (Won) 85,571    56.5 %
                                       

(1)

Excludes credit card loans, but includes overdraft loans.

Our retail loans consist of:

 

   

Mortgage loans, which are loans made to customers to finance home purchases, construction, improvements or rentals; and home equity loans, which are loans made to our customers secured by their homes to ensure loan repayment. We also provide overdraft loans in connection with our home equity loans.

 

   

Other consumer loans, which are loans made to customers for any purpose (other than mortgage and home equity loans). These include overdraft loans, which are loans extended to customers to cover insufficient funds when they withdraw funds from their demand deposit accounts with us in excess of the amount in such accounts up to a limit established by us.

 

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For secured loans, including mortgage and home equity loans, our policy is to lend up to 100% of the adjusted collateral value (except in areas of high speculation designated by the government where we are required to limit our lending to 40% of the appraised value of collateral) minus the value of any lien or other security interest that is prior to our security interest. In calculating the adjusted collateral value for real estate, we use the appraisal value of the collateral multiplied by a factor, generally between 40% to 60%. This factor varies depending upon the location and use of the real estate and is established in part by taking into account court-supervised auction prices for nearby properties.

A borrower’s eligibility for our mortgage loans depends on value of the mortgage property, the appropriateness of the use of proceeds and the borrower’s creditworthiness. A borrower’s eligibility for home equity loans is determined by the borrower’s credit and the value of the property, while the borrower’s eligibility for other consumer loans is primarily determined by the borrower’s credit. If the borrower’s credit deteriorates, it may be difficult for us to recover the loan. As a result, we review the borrower’s creditworthiness, collateral value, credit scoring and third party guarantees when evaluating a borrower. In addition, to reduce the interest rate of a loan or to qualify for a loan, a borrower may provide collateral, deposits or guarantees from third parties.

Due to a rapid increase in retail loans and increased credit risks relating thereto, as well as to stabilize the real estate market in Korea, the Financial Supervisory Commission and the Financial Supervisory Service have been adopting more stringent guidelines applicable to mortgage and home equity lending by Korean banks since 2002. See “Item 3D. Risk Factors—Risks relating to government regulation and policy” and “—Supervision and Regulation—Principal Regulations Applicable to Banks—Liquidity—Recent Regulations Relating to Retail Household Loans.”

Mortgage and Home Equity Lending

Our mortgage and home equity lending has substantially expanded in recent years.

The Housing Finance Market in Korea. The housing finance market in Korea is divided into public sector and private sector lending. In the public sector, two government entities, the National Housing Fund and the National Agricultural Cooperative Federation, are responsible for most of the mortgage lending. In the private sector, a number of financial institutions and installment finance companies, including us, provide mortgage lending. Prior to 1997, government regulations limited the types of mortgage lending products commercial banks in Korea could offer. These restrictions affected both the terms of mortgages that could be offered as well as eligibility of properties to be mortgaged and persons applying for mortgages. Government restrictions on mortgage lending were largely lifted in 1997, leading to a more competitive mortgage lending market. In 1998, the government promulgated new laws to facilitate asset securitization transactions by Korean banks. Such developments have contributed to the growth of the mortgage lending market by increasing the amount of funding available to lenders and allowing lenders to manage their credit risk.

Mortgage and Home Equity Loan Products. We provide customers with a number of mortgage and home equity loan products that have flexible features, including terms, repayment schedules, amounts and eligibility for loans, and we offer interest rates on a commercial basis. Although the maximum term of mortgage loans is 35 years, the majority of our mortgage loans have significantly shorter maturities, which may be renewed. Non-amortizing home equity loans have an initial maturity of three years, which may be extended on an annual basis for a maximum of ten years. Home equity loans subject to amortization of principal may have a maximum term of up to 35 years. Any customer is eligible for a mortgage or an individual home equity loan regardless of whether it participates in one of our housing related savings programs and so long as that customer is not barred by regulation from obtaining a loan because of bad credit history. However, customers with whom we frequently transact business and provide us with significant revenue receive preferential interest rates on loans.

 

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As of December 31, 2006, 57.2% of our mortgage loans were secured by residential property which is the subject of the loan, 9.3% of our mortgage loans were guaranteed by the Housing Finance Credit Guarantee Fund, a government housing-related entity, and the remaining 33.5% of our mortgage loans, contrary to general practices in the United States, were unsecured (although the use of proceeds from these loans are restricted for the purpose of financing home purchases and some of these loans were guaranteed by a third party). One reason that a relatively high percentage of our mortgage loans are unsecured is that we, along with other Korean banks, provide advance loans to borrowers for the down payment of new housing (particularly apartments) that is in the process of being built. Once construction is completed, which may take several years, these mortgage loans become secured by the new housing purchased by these borrowers. For the year ended December 31, 2006, the average initial loan-to-value ratio of our mortgage loans, which is a measure of the amount of loan exposure to the appraised value of the security collateralizing the loan, was approximately 52.3%. There are three reasons that our loan-to-value ratio is relatively lower (as is the case with other Korean banks) compared to similar ratios in other countries, such as the United States. The first reason is that housing prices are high in Korea relative to average income, so most people cannot afford to borrow an amount equal to the entire value of their collateral and make interest payments on such an amount. The second reason relates to the “jeonsae” system, through which people provide a key money deposit while residing in the property prior to its purchase. At the time of purchase, most people use the key money deposit as part of their payment and borrow the remaining amount from Korean banks, which results in a loan that will be for an amount smaller than the appraised value of the property for collateral and assessment purposes. The third reason is that Korean banks discount the appraised value of the borrower’s property for collateral and assessment purposes so that a portion of the appraised value is reserved in order to provide recourse to a renter who lives at the borrower’s property. This is in the event that the borrower’s property is seized by a creditor, and the renter is no longer able to reside at that property. See “Item 3D. Risk Factors—Other risks relating to our business—A decline in the value of the collateral securing our loans and our inability to realize full collateral value may adversely affect our credit portfolio.” As a result of government initiatives, we have also tightened our mortgage loan guidelines.

Pricing. The interest rates on our retail mortgage loans are generally based on a periodic floating rate (which is based on a base rate determined for three-month, six-month or twelve-month periods derived using our Market Opportunity Rate system, which reflects our internal cost of funding, further adjusted to account for our expenses related to lending). Our interest rates also incorporate a margin based among other things on the type of security, the credit score of the borrower and the estimated loss on the security. We can adjust the price to reflect the borrower’s current and/or expected future contribution to us. The applicable interest rate is determined at the time of the loan. If a loan is terminated prior to its maturity, the borrower is obligated to pay us an early termination fee of approximately 0.7% to 1.4% of the loan amount in addition to the accrued interest.

The interest rates on our home equity loans are determined on the same basis as our retail mortgage loans.

As of December 31, 2006, our current three-month, six-month and twelve-month base rates were 6.00%, 6.01% and 6.13%, respectively.

As of December 31, 2006, 99.6% of our outstanding mortgage and home equity loans was priced based on a floating rate and 0.4% was priced based on a fixed rate.

Other Consumer Loans

Other consumer loans are primarily unsecured. However, such loans may be secured by real estate, deposits or securities. As of December 31, 2006, approximately (Won)11,706 billion, or 54.2% of our consumer loans (other than mortgage and home equity loans) were unsecured loans (although some of these loans were guaranteed by a third party). Overdraft loans are also classified as other consumer loans, are primarily unsecured and typically have a maturity between one and three years. The amount of overdraft loans as of December 31, 2006 was approximately (Won)7,481 billion.

 

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Pricing. The interest rates on our other consumer loans are determined on the same basis as on our home equity loans, except that, for unsecured loans, the borrower’s credit score as determined during our loan approval process is also taken into account. See “Item 11. Quantitative and Qualitative Disclosures about Market Risk—Credit Risk Management.” For overdraft loans, we also add 50 basis points in determining the interest rate.

As of December 31, 2006, 99.6% of our other consumer loans had interest rates that were not fixed but were variable in reference to our base rate, which is based on the Market Opportunity Rate.

Deposit-taking Activities

Due to our extensive nationwide network of branches and the merger, together with our long history of development and our resulting know-how and expertise, as of December 31, 2006, we had the largest number of retail customers and retail deposits among Korean commercial banks. The balance of our deposits from retail customers was (Won)94,024 billion, (Won)94,817 billion and (Won)89,356 billion as of December 31, 2004, 2005 and 2006, respectively, which constituted 74.5%, 75.4% and 69.0% respectively, of the balance of our total deposits.

We offer many deposit products that target different segments of our retail customer base, with features tailored to each segment’s financial profile, characteristics and needs, including:

 

   

Demand deposits, which either do not accrue interest or accrue interest at a lower rate than time or savings deposits. Demand deposits allow the customer to deposit and withdraw funds at any time and, if they are interest bearing, accrue interest at a variable rate depending on the amount of deposit. Retail and corporate demand deposits constituted 3.9% of our total deposits as of December 31, 2006 and paid average interest of 1.76% for 2006.

 

   

Time deposits, which generally require the customer to maintain a deposit for a fixed term, during which the deposit accrues interest at a fixed rate or a variable rate based on the Korea Composite Stock Prices Index (known as “KOSPI”), or to deposit specified amounts on an installment basis. If the amount of the deposit is withdrawn prior to the end of the fixed term, the customer will be paid a lower interest rate than that originally offered. The term for time deposits typically range from one month to five years, and the term for installment savings deposits range from six months to ten years. Retail and corporate time deposits constituted 47.8% of our total deposits as of December 31, 2006 and paid average interest of 3.92% for 2006. Most installment savings deposits offer fixed interest rates.

 

   

Savings deposits, which allow depositors to deposit and withdraw money at any time and accrue interest at an adjustable interest rate, which is currently below 3.3%. Retail and corporate savings deposits constituted 33.8% of our total deposits as of December 31, 2006 and paid average interest of 0.71% for 2006.

 

   

Certificates of deposit, the maturities of which range from 30 days to 365 days with a required minimum deposit of (Won)5 million. Interest rates on certificates of deposit are determined based on the length of the deposit and prevailing market rates. Our certificates of deposit are sold at a discount to their face value, reflecting the interest payable on the certificate of deposit.

 

   

Foreign currency deposits, which accrue interest at an adjustable rate and are available to Korean residents, non-residents and overseas immigrants. We offer foreign currency time deposits and checking and passbook accounts in ten currencies.

We offer varying interest rates on our deposit products depending upon average funding costs, the rate of return on our interest earning assets and the interest rates offered by other commercial banks.

We also offer deposits that provide the holder with preferential rights to housing subscriptions and eligibility for mortgage loans. These products include:

 

   

Housing subscription time deposits, which are special purpose time deposit accounts providing the holder with a preferential right to subscribe for new private apartment units under the Housing Law.

 

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This law is the basic law setting forth various measures supporting the purchase of houses and the supply of such houses by construction companies. These products accrue interest at a fixed rate for one year, and at an adjustable rate after one year. Deposit amounts per account range from (Won)2 million to (Won)15 million depending on the location of the holder’s current residence and the size of the desired apartment unit. These deposit products target high and middle income households.

 

   

Housing subscription installment savings deposits, which are monthly installment savings programs providing the holder with a preferential subscription right for new private apartment units under the Housing Law. Account holders are also eligible for our mortgage loans. These deposits require monthly installments of (Won)50,000 to (Won)500,000, have maturities of between two and five years and accrue interest at fixed or variable rates depending on the term. These deposit products target low- and middle-income households.

We have a “priority customer” program called KB Star Club that categorizes our customers by their average deposit balance for the most recent three-month period, the amount of their transactions with us and their program points based on such balances and transactions. A customer may receive preferential treatment in various areas, including interest rates and transaction fees, depending upon how the customer is classified. As of December 31, 2006, we had over three million KB Star Club customers, representing approximately 12.8% of our total retail customer base of over 25 million retail customers. In 2006, on an average balance basis, our KB Star Club customers held approximately 81.1% of our total retail customer deposits, and revenues from our KB Star Club customers accounted for approximately 62.2% of our revenues derived from our retail customers.

In 2002, after significant research and planning, we launched private banking operations at our headquarters. Shortly thereafter, we launched a comprehensive strategy with respect to customers with higher net worth, which included staffing appropriate representatives, marketing aggressively, establishing IT systems, selecting appropriate branch locations and readying such branches with the necessary facilities to service such customers. As of December 31, 2006, we had established 18 centers (including 1 sub-center) and plan to increase the number of private banking centers as necessary. We believe that by offering high quality personal wealth management services to these customers we can increase our share of the priority customer market, which will increase our profitability and our position in the retail banking market.

The Monetary Policy Committee of the Bank of Korea (the “Monetary Policy Committee”) imposes a reserve requirement on Won currency deposits of commercial banks based generally on the type of deposit instrument. The reserve requirement is currently up to 7%. See “—Supervision and Regulation—Principal Regulations Applicable to Banks—Liquidity.”

The Depositor Protection Act provides for a deposit insurance system where the Korea Deposit Insurance Corporation guarantees to depositors the repayment of their eligible bank deposits, which do not include foreign currency deposits. The deposit insurance system insures up to a total of (Won)50 million per depositor per bank. See “—Supervision and Regulation—Principal Regulations Applicable to Banks—Deposit Insurance System.” We pay a premium rate of 0.2% of our average deposits and we paid (Won)218 billion for 2006.

Credit Cards

Credit cards are another of our core retail products. As a result of the merger with H&CB, for a period of time we issued and operated two brands of credit cards, Kookmin Card and BC Card. Following our merger with our subsidiary, Kookmin Credit Card, in September 2003, we adopted a strategy of trying to unify the two brands. Accordingly, commencing in October 2003, we have been issuing most of our new credit cards under the “KB Card” brand.

 

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The following table sets forth certain data relating to our credit card operations. All financial figures appearing below have been prepared in accordance with Korean GAAP, which differs significantly from U.S. GAAP. See “Item 5B. Liquidity and Capital Resources—Reconciliation with Korean GAAP.”

 

     As of and for the year
ended December 31,
 
     2004(1)     2005     2006  
     (in billions of Won, except
number of holders, accounts and
percentages)
 

Number of credit cardholders (at year end) (thousands)

      

General accounts

     11,362       9,343       8,883  

Corporate accounts

     182       159       173  
                        

Total

     11,544       9,502       9,056  
                        

Number of merchants (at year end) (thousands)

     1,492       1,507       1,610  

Active ratio (at year end) (2)

     54.9 %     62.7 %     68.4 %

Credit card fees

      

Merchant fees (3)

   (Won) 803     (Won) 788     (Won) 868  

Installment and cash advance fees

     1,388       1,018       864  

Annual membership fees

     45       41       37  

Other fees

     401       234       286  
                        

Total

   (Won) 2,637     (Won) 2,081     (Won) 2,055  
                        

Charge volume (4)

      

General purchase

   (Won) 25,373     (Won) 29,836     (Won) 34,307  

Installment purchase

     7,520       6,748       7,019  

Cash advance

     33,456       24,261       19,837  

Card loan (5)

     2,999       1,002       2,554  
                        

Total

   (Won) 69,348     (Won) 61,847     (Won) 63,717  
                        

Outstanding balance (at year end) (6)

      

General purchase

   (Won) 1,808     (Won) 2,491     (Won) 2,832  

Installment purchase

     1,524       1,544       1,740  

Cash advance

     2,934       2,562       2,348  

Card loan (5)

     1,378       975       1,748  
                        

Total (7)

   (Won) 7,644     (Won) 7,572     (Won) 8,668  
                        

Average outstanding balances (6)

      

General purchase

   (Won) 1,804     (Won) 2,045     (Won) 2,564  

Installment purchase

     2,027       1,479       1,559  

Cash advance

     3,497       2,689       2,396  

Card loan (5)

     2,256       1,111       1,338  

Delinquency ratios (at year end) (8)

      

Less than 1 month

     1.48 %     1.03 %     0.97 %

From 1 month to 3 months

     3.32       1.70       1.13  

From 3 months to 6 months

     0.29       0.18       0.27  

Over 6 months

     0.11       0.11       0.11  
                        

Total

     5.20 %     3.01 %     2.47 %
                        

Non-performing loan ratio

      

Reported

     4.55 %     2.19 %     1.29 %

Managed

     3.91 %     2.05 %     1.26 %

Write-offs (gross)

   (Won) 3,261     (Won) 868     (Won) 496  

Recoveries (9)

     131       233       236  
                        

Net write-offs

   (Won) 3,130     (Won) 635     (Won) 260  
                        

 

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     As of and for the year
ended December 31,
 
     2004(1)     2005     2006  
     (in billions of Won, except
number of holders, accounts and
percentages)
 

Gross write-off ratio (10)

     34.04 %     11.85 %     6.31 %

Net write-off ratio (11)

     32.66 %     8.67 %     3.31 %

Asset sales

     —         —         —    

Asset securitization (12)

   (Won) 1,790     (Won) 810     (Won) 305  

(1)

Includes data for credit cards issued under the Kookmin Card and BC Card brands prior to September 2004.

(2)

The active ratio represents the ratio of accounts used at least once within the last six months to total accounts as of year end.

(3)

Merchant fees consist of merchant membership and maintenance fees, costs associated with prepayment by us (on behalf of customers) of sales proceeds to merchants, processing fees relating to sales and membership applications, costs relating to the management of delinquencies and recoveries, bad debt expenses, general variable expenses and other fixed costs that are charged to our member merchants. We charge our member merchants fees that range from 1.0% to 4.5%.

(4)

Represents the aggregate cumulative amount charged during the year.

(5)

Card loans consist of loans that are provided on either a secured or unsecured basis to cardholders upon prior agreement. Payment of principal, fees and interest on such a loan can be due either in one payment or in installments after a fixed period.

(6)

Includes certain interest trust certificates issued by special purpose entities in connection with asset securitization transactions of our underlying credit card balances. Transfers of credit card balances to special purpose entities in connection with asset securitization transactions are recognized as sales under Korean GAAP but not under U.S. GAAP.

(7)

The total outstanding balances pursuant to U.S. GAAP for all of our credit cards were (Won)9,421 billion as of December 31, 2004, (Won)8,369 billion as of December 31, 2005 and (Won)8,955 billion as of December 31, 2006.

(8)

Represents the ratio of delinquencies to outstanding balance. In line with industry practice, we have restructured a large portion of delinquent credit card account balances (defined as balances overdue for one day or more) as loans and have also replaced a portion of our delinquent credit card account balances with cash advances that are rolled over from month to month. We discontinued the practice of providing substituted cash advances from January 2004. As of December 31, 2006, these restructured loans amounted to (Won)139 billion. Because these restructured loans are not treated as being delinquent at the time of conversion or for a period of time thereafter, our delinquency ratios may not fully reflect all delinquent amounts relating to our outstanding balances.

(9)

Does not include proceeds that we received from sales of our non-performing loans that were written off.

(10)

Represents the ratio of gross write-offs for the year to average outstanding balance for the year. Under Korean GAAP, our charge-off policy is generally to write off balances which have been overdue for four payment cycles or more or which have been classified as expected loss. In 2004, our write-off ratio under Korean GAAP increased considerably due to significant repurchases and subsequent write-offs of credit card receivables underlying asset-backed securities that were issued in late 2002.

(11)

Represents the ratio of net write-offs for the year to average outstanding balances for the year. Under Korean GAAP, our charge-off policy is generally to write off balances which have been overdue for four payment cycles or more or which have been classified as expected loss. In 2004, our write-off ratio under Korean GAAP increased considerably due to significant repurchases and subsequent write-offs of credit card receivables underlying asset-backed securities that were issued in late 2002.

(12)

Comprises credit card balances that were transferred in asset securitization transactions. Under U.S. GAAP, these transfers are not recognized as sales.

The use of credit cards in Korea has increased dramatically in recent years as the Korean economy and consumer spending recovered from the recent financial and economic difficulties and, as a result of government

 

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initiatives promoting the use of credit cards in Korea. For example, the government requires commercial merchants to accept credit cards as a means of preventing tax evasion by ensuring proper disclosure of transactions and provides tax benefits to businesses that accept credit cards. For consumers, there is also a tax deduction for certain amounts spent using credit cards. However, there has been significant concern in Korea regarding the high levels of credit card usage (including cash advances) and the deteriorating asset quality of credit card portfolios of Korean financial institutions. Commencing in July 2002, the Financial Supervisory Commission increased regulation of the credit card industry. See “Item 3D. Risk Factors—Risks relating to government regulation and policy” and “—Supervision and Regulation—Principal Regulations Applicable to Banks—Credit Card Business.”

In contrast to the system in the United States and many other countries, where most credit cards are revolving cards that allow outstanding amounts to be rolled over from month to month so long as a required minimum percentage is repaid, credit cardholders in Korea are generally required to pay for their purchases within approximately 20 to 60 days of purchase depending on their payment cycle. However, we also offer revolving cards to individuals that allow outstanding amounts to be rolled over to subsequent payment periods. Delinquent accounts (defined as amounts overdue for one day or more) are charged penalty interest and closely monitored. For installment purchases, we charge interest on unpaid installments at rates that vary according to the terms of repayments. See “Item 3D. Risk Factors—Risks relating to our retail credit portfolio.”

We believe that by establishing a unified credit card business through our merger with Kookmin Credit Card and our adoption of the new KB Card brand, we have further enhanced this business by strengthening our risk management and maximizing our operational efficiency. In addition, we believe that our extensive branch network, brand recognition and overall size will enable us to cross-sell products such as credit cards to our existing and new customers.

To promote our credit card business, we offer services targeted to various financial profiles and customer requirements and are concentrating on:

 

   

strengthening cross-sales to existing customers and offering integrated financial services;

 

   

offering cards that provide additional benefits such as frequent flyer miles and reward program points that can be redeemed by the customer for complementary services, prizes and cash;

 

   

offering gold cards, platinum cards and other prime members’ cards, which have a higher credit limit and provide additional services in return for a higher fee;

 

   

acquiring new customers through strategic alliances and cross-marketing with retailers;

 

   

encouraging increased use of credit cards by existing customers through special offers for frequent users;

 

   

introducing new features, such as revolving credit cards, travel services and insurance;

 

   

developing fraud detection and security systems to prevent the misuse of credit cards and to encourage the use of credit cards over the Internet; and

 

   

issuing smart cards and preparing for a cardless business environment in which customers can use credit cards to make purchases by phone or over the Internet.

As of December 31, 2006, we had more than 9 million cardholders. Of the credit cards outstanding, 68.4% were active, meaning that they had been used at least once during the previous six months. For 2006, our market share with respect to charge volume was 16.4% according to the Financial Supervisory Service.

Our card revenues consist principally of cash advance fees, merchant fees, credit card installment fees, interest income from credit card loans, annual fees paid by cardholders and interest and fees on late payments. Cardholders are generally required to pay for their purchases within 17 to 47 days after the date of purchase,

 

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depending on their payment cycle. Except in the case of installment purchases, accounts which remain unpaid after this period are deemed to be delinquent.

We generate other fees through a processing charge on merchants, with the average charge equaling 2.46%.

Under non-exclusive license agreements with MasterCard International Incorporated and Visa International Service Association, we also issue MasterCard and Visa credit cards.

We launched our debit card business in 1996 in response to changing customer needs. We charge merchants an average commission of approximately 1.64% of the amounts purchased using a debit card. We also issue “check cards”, which are similar to debit cards except that “check cards” are accepted by all merchants that accept credit cards. Much like debit cards, “check card” purchases are also debited directly from customers’ accounts with us. As of December 31, 2006, we had approximately 5.1 million “check card” holders, who effected “check card” transactions totaling approximately (Won)2,767 billion in 2006.

Corporate Banking

We lend to and take deposits from small- and medium-sized enterprises and, to a lesser extent, large corporate customers. As of December 31, 2004, 2005 and 2006, we had 155,323, 143,838 and 153,213 small- and medium-sized enterprise borrowers and 713, 679 and 719 large corporate borrowers, respectively. For 2004, 2005 and 2006, we received fee revenue from “firm banking” services offered to corporate customers, which include inter-account transfers, transfers of funds from various branches and agencies of a company (such as insurance premium payments) to the account of the headquarters of such company and transfers of funds from various customers of a company to the main account of such company, in the amount of (Won)68 billion, (Won)78 billion and (Won)86 billion, respectively. Of our branch network as of December 31, 2006, we had 96 branches dedicated exclusively to corporate banking.

The following table sets forth the balances and the percentage of our total lending represented by our small- and medium-sized enterprise business loans and our large corporate business loans as of the dates indicated, estimated based on our internal classifications of corporate borrowers under Korean GAAP:

 

     As of December 31,  
     2004     2005     2006  
     (in billions of Won, except percentages)  

Corporate:

               

Small- and medium-sized enterprise loans

   (Won) 38,240    27.7 %   (Won) 36,344    26.3 %   (Won) 41,498    27.4 %

Large corporate loans

     5,417    3.9       9,813    7.1       14,598    9.7  
                                       

Total

   (Won) 43,657    31.6 %   (Won) 46,157    33.4 %   (Won) 56,096    37.1 %
                                       

On the deposit-taking side, we currently offer our corporate customers several types of corporate deposits. Our corporate deposit products can be divided into two general categories: (1) demand deposits that have no restrictions on deposits or withdrawals, but which offer a relatively low interest rate; and (2) deposits from which withdrawals are restricted for a period of time, but offer higher interest rates. We also offer installment savings deposits, certificates of deposit and repurchase instruments. We offer varying interest rates on deposit products depending upon the rate of return on our income-earning assets, average funding costs and interest rates offered by other nationwide commercial banks.

The total amount of deposits from our corporate customers amounted to (Won)32,570 billion as of December 31, 2006, or 25.1% of our total deposits.

 

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Small- and Medium-sized Enterprise Banking

Our small- and medium-sized enterprise banking business has traditionally been and will remain one of our core businesses because of both our historical development and our accumulated expertise. In recent years, we have largely focused our corporate banking activities on the small- and medium-sized enterprise market in Korea. We believe that we possess the necessary elements to succeed in the small- and medium-sized enterprise market, including our extensive branch network, our credit rating system for credit approval, our marketing capabilities (which we believe have provided us with significant brand loyalty) and our ability to take advantage of economies of scale.

We use the term “small- and medium-sized enterprises” as defined in the Small and Medium Industry Basic Act and related regulations. The general criterion used to define small- and medium-sized enterprises is either the number of full-time employees (less than 300), paid-in capital (equal to or less than (Won)8 billion) or sales revenues (equal to or less than (Won)30 billion). Criteria differ from industry to industry. In all cases, however, the number of full-time employees may not equal or exceed 1,000.

Lending Activities

Our principal loan products for our small- and medium-sized enterprise customers are working capital loans and facilities loans. Working capital loans are provided to finance working capital requirements and include notes discounted and trade financing. Facilities loans are provided to finance the purchase of equipment and the establishment of manufacturing assembly plants. As of December 31, 2006, working capital loans and facilities loans accounted for 85.5% and 14.5%, respectively, of our total small- and medium-sized enterprise loans. As of December 31, 2006, we had over 153,000 small- and medium-sized enterprise customers.

Loans to small- and medium-sized enterprises may be secured by real estate or deposits or may be unsecured. As of December 31, 2006, secured loans and guaranteed loans accounted for, in the aggregate, 85.0% of our small- and medium-sized enterprise loans. Among the secured loans, 51.7% were secured by real estate and 48.3% were secured by deposits or securities. Working capital loans generally have a maturity of one year, but may be extended on an annual basis for an aggregate term of three years. Facilities loans have a maximum maturity of ten years.

When evaluating the extension of working capital loans, we review the corporate customer’s creditworthiness and capability to generate cash. Furthermore, we take personal guarantees and credit guaranty letters from other financial institutions and use time and savings deposits that the borrower has with us as collateral, and may require additional collateral. We receive fees in relation to credit evaluation, collateral appraisal and other services provided in connection with a loan extension.

The value of any collateral is defined using a formula that takes into account the appraised value of the property, any prior liens or other claims against the property and an adjustment factor based on a number of considerations including, with respect to property, the value of any nearby property sold in a court-supervised auction during the previous 3.5 years. We revalue any collateral on a periodic basis (generally every year) or if a trigger event occurs with respect to the loan in question.

We also offer collective housing loans. Our collective housing loans are mortgage loans to home builders or developers who build or sell single- or multi-family housing units, principally apartment buildings. Many of these builders and developers are categorized as small- and medium-sized enterprises. We offer a variety of collective housing loans, including loans to purchase property or finance the construction of housing units, loans to contractors used for working capital purposes, and loans to educational establishments, small- and medium-sized enterprises and non-profit entities to finance the construction of dormitories. Collective housing loans subject us to the risk that the housing units will not be sold. As a result, we review the probability of the sale of the housing unit when evaluating the extension of a loan. We also review the borrower’s creditworthiness and the

 

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adequacy of the intended use of proceeds. Furthermore, we take a lien on the land on which the housing unit is to be constructed as collateral. If the collateral is not sufficient to cover the loan, we also take a guarantee from the Housing Finance Credit Guarantee Fund as security.

A substantial number of our small- and medium-sized enterprise customers are SOHOs, which represent sole proprietorships, individual business interests and very small corporations. We generally diversify SOHOs into two groups. The first group are those who do not typically maintain financial statements. We generally lend to this group on a secured basis. For these SOHOs we apply a strict credit risk evaluation model, which not only uses quantitative analysis related to a customer’s accounts and due amounts but also requires our credit officers to perform a qualitative analysis of each potential SOHO customer. The second group are those who maintain a double-entry book keeping system. We usually lend to this group on an unsecured basis. We evaluate the risk of this segment through the corporate credit risk system, which takes into account both financial and non-financial criteria.

Pricing

We establish the price for our corporate loan products (other than collective housing loans) based principally on transaction risk, our cost of funding and market considerations. Transaction risk is measured by such factors as the credit rating assigned to a particular borrower, the size of the borrower and the value and type of collateral. Our loans are priced based on the Market Opportunity Rate system.

Our Market Opportunity Rate system is a periodic floating rate system which takes into account the current market interest rate and an activity-based cost, and a spread calculated to achieve a target “return on asset” ratio set for the year. As of December 31, 2006, the Market Opportunity Rate was 4.80% for three months, 4.81% for six months and 4.93% for one year.

While we generally utilize the Market Opportunity Rate system, depending on the price and other terms set by competing banks for similar borrowers, we may adjust the interest rate we charge to compete more effectively with other banks.

The interest rates on our collective housing loans are based on a periodic floating rate, which in turn is based on a base rate determined for three-month, six-month or twelve-month periods derived using our Market Opportunity Rate system. After selecting the appropriate periodic floating rate, our loan analysis system raises or lowers the floating rate based on various factors related to the loan and the borrower. In addition, we take into account the market conditions and our expenses and services to be provided with respect to such loan. The repayment schedule differs according to the variable term, repayment method and the particular loan. If a loan is terminated prior to its maturity, the corporate borrower is obligated to pay us an early termination fee in addition to the accrued interest.

Large Corporate Banking

Large corporate customers include all companies that are not small- and medium-sized enterprise customers. Due to our history of development and limitations in our articles of incorporation, large corporate banking was not a core business of the former Kookmin Bank or of H&CB prior to the merger. Our articles of incorporation provide that financial services to large corporate customers must be no more than 40% of the total amount of our Won-denominated loans. Our business focus with respect to large corporate banking has shifted from a concentration on risk management to selective expansion, within the constraints of our articles of incorporation. Specifically, we are carrying out various initiatives to improve our customer relationship with large corporate customers and plan to expand our service offerings to this segment.

 

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Lending Activities

Our principal loan products for our large corporate customers are working capital loans and facilities loans. As of December 31, 2006, working capital loans and facilities loans accounted for 96.9% and 3.1%, respectively, of our total large corporate loans. We also offer collective housing loans, as described above under “—Small- and Medium-sized Enterprise Banking—Lending Activities,” to large corporate clients.

As of December 31, 2006, secured loans and guaranteed loans accounted for, in the aggregate, 14.2% of our large corporate loans. Among the secured loans, 36.5% were secured by real estate and 63.5% were secured by deposits or securities. Working capital loans generally have a maturity of one year but are extended on an annual basis for an aggregate term of three years. Facilities loans have a maximum maturity of 10 years.

We evaluate creditworthiness and collateral for our large corporate loans in essentially the same way as we do for small- and medium-sized enterprise loans. See “—Small- and Medium-sized Enterprise Banking—Lending Activities” above.

As of December 31, 2006, in terms of our outstanding loan balance, 33.5% of our large corporate loans was extended to borrowers in the manufacturing industry, 16.6% was extended to borrowers in the construction industry, and 15.1% was extended to borrowers in the financial and insurance industry.

Pricing

We determine pricing of our large corporate loans in the same way as we determine the pricing of our small- and medium-sized enterprise loans. See “—Small- and Medium-sized Enterprise Banking—Pricing” above. As of December 31, 2006, the Market Opportunity Rate, which is utilized in pricing loans offered by us, was the same for our large corporate loans as for our small- and medium-sized enterprise loans.

Capital Markets Activities and International Banking

Through our capital markets operations, we invest and trade in debt and equity securities and, to a lesser extent, engage in derivatives and asset securitization transactions and make call loans.

Securities Investment and Trading

We invest in and trade securities for our own account in order to maintain adequate sources of liquidity and to generate interest and dividend income and capital gains. As of December 31, 2004, 2005 and 2006, our investment portfolio, which consists primarily of held-to-maturity securities and available-for-sale securities, and our trading portfolio had a combined total book value of (Won)26,790 billion, (Won)28,924 billion and (Won)27,922 billion and represented 15.1%, 16.2% and 14.5% of our total assets, respectively.

Our trading and investment portfolios consist primarily of Korean treasury securities and debt securities issued by Korean government agencies, local governments or certain government-invested enterprises and debt securities issued by financial institutions. As of December 31, 2004, 2005 and 2006, we held debt securities with a total book value of (Won)25,512 billion, (Won)27,876 billion and (Won)26,033 billion, respectively, of which:

 

   

held-to-maturity debt securities accounted for (Won)6,168 billion, (Won)10,498 billion and (Won)10,963 billion, or 24.2%, 37.7% and 42.1%, respectively;

 

   

available-for-sale debt securities accounted for (Won)15,898 billion, (Won)14,027 billion and (Won)12,641 billion, or 62.3%, 50.3% and 48.6%, respectively; and

 

   

trading debt securities accounted for (Won)3,446 billion, (Won)3,351 billion and (Won)2,429 billion, or 13.5%, 12.0% and 9.3%, respectively.

 

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Of these amounts, debt securities issued by the Korean government and government agencies as of December 31, 2004, 2005 and 2006 amounted to:

 

   

(Won)4,748 billion, (Won)6,209 billion and (Won)8,316 billion, or 77.0%, 59.1% and 75.9%, respectively, of our held-to-maturity debt securities;

 

   

(Won)3,735 billion, (Won)3,394 billion and (Won)3,708 billion, or 23.5%, 24.2% and 29.3%, respectively, of our available-for-sale debt securities; and

 

   

(Won)916 billion, (Won)1,756 billion and (Won)478 billion, or 26.6%, 52.4% and 19.7%, respectively, of our trading debt securities.

From time to time we also purchase equity securities for our securities portfolios. Our equity securities consist primarily of marketable beneficiary certificates and equities listed on the Stock Market Division of the Korea Exchange or KOSDAQ Market Division of the Korea Exchange. As of December 31, 2004, 2005 and 2006:

 

   

equity securities in our available-for-sale portfolio had a book value of (Won)252 billion, (Won)128 billion and (Won)1,007 billion, or 1.6%, 0.9% and 7.4% of our available-for-sale portfolio, respectively; and

 

   

equity securities in our trading portfolio had a book value of (Won)249 billion, (Won)201 billion and (Won)145 billion, or 6.7%, 5.7% and 5.6% of our debt and equity trading portfolio, respectively.

Our trading portfolio also includes foreign exchange spot contracts and derivative instruments. See “—Derivatives Trading.” Our investment portfolio also includes venture capital activities, non-marketable or restricted equity securities, investments under the equity method and investments held by our asset management subsidiary. As of December 31, 2004, 2005 and 2006, these investments had an aggregate book value of (Won)777 billion, (Won)719 billion and (Won)737 billion, respectively.

The following tables show, as of the dates indicated, the gross unrealized gains and losses on available-for-sale and held-to-maturity securities within our investment securities portfolio, and the amortized cost and fair value of the portfolio by type of investment security:

 

     As of December 31, 2004
     Amortized
cost
   Gross
unrealized
gain
   Gross
unrealized
loss
   Fair value
     (in billions of Won)

Available-for-sale securities:

           

Debt securities

           

Korean treasury securities and government agencies

   (Won) 3,689    (Won) 48    (Won) 1    (Won) 3,736

Corporate (1)

     801      22      5      818

Financial institutions (2)

     11,103      38      6      11,135

Foreign governments

     37      5      —        42

Asset-backed securities

     166      1      —        167

Subtotal

     15,796      114      12      15,898
                           

Marketable equity securities

     225      27      —        252
                           

Total available-for-sale securities

   (Won) 16,021    (Won) 141    (Won) 12    (Won) 16,150
                           

Held-to-maturity securities:

           

Korean treasury securities and government agencies

   (Won) 4,748    (Won) 206      —      (Won) 4,954

Corporate (3)

     65      1      —        66

Financial institutions (4)

     1,242      5      —        1,247

Foreign governments

     —        —        —        —  

Asset-backed securities

     113      2      —        115
                           

Total held-to-maturity securities

   (Won) 6,168    (Won) 214      —      (Won) 6,382
                           

 

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     As of December 31, 2005
     Amortized
cost
   Gross
unrealized
gain
   Gross
unrealized
loss
   Fair value
     (in billions of Won)

Available-for-sale securities:

           

Debt securities

           

Korean treasury securities and government agencies

   (Won) 3,426    (Won) 3    (Won) 35    (Won) 3,394

Corporate (1)

     569      9      8      570

Financial institutions (2)

     9,969      3      41      9,931

Foreign governments

     17      2      —        19

Asset-backed securities

     114      —        2      112

Other debt securities

     1      —        —        1

Subtotal

     14,096      17      86      14,027
                           

Marketable equity securities

     93      39      4      128
                           

Total available-for-sale securities

   (Won) 14,189    (Won) 56    (Won) 90    (Won) 14,155
                           

Held-to-maturity securities:

           

Korean treasury securities and government agencies

   (Won) 6,209    (Won) 37    (Won) 168    (Won) 6,078

Corporate (3)

     125      —        5      120

Financial institutions (4)

     3,870      —        42      3,828

Foreign governments

     —        —        —        —  

Asset-backed securities

     294      —        4      290
                           

Total held-to-maturity securities

   (Won) 10,498    (Won) 37    (Won) 219    (Won) 10,316
                           
     As of December 31, 2006
     Amortized
cost
   Gross
unrealized
gain
   Gross
unrealized
loss
   Fair value
     (in billions of Won)

Available-for-sale securities:

           

Debt securities

           

Korean treasury securities and government agencies

   (Won) 3,716    (Won) 1    (Won) 9    (Won) 3,708

Corporate (1)

     573      20      4      589

Financial institutions (2)

     8,198      1      15      8,184

Foreign governments

     9      —        —        9

Asset-backed securities

     152      —        1      151

Other debt securities

     —        —        —        —  

Subtotal

     12,648      22      29      12,641
                           

Marketable equity securities

     378      675      46      1,007
                           

Total available-for-sale securities

   (Won) 13,026    (Won) 697    (Won) 75    (Won) 13,648
                           

Held-to-maturity securities:

           

Korean treasury securities and government agencies

   (Won) 8,316    (Won) 47    (Won) 92    (Won) 8,271

Corporate (3)

     215      —        3      212

Financial institutions (4)

     2,227      —        13      2,214

Foreign governments

     —        —        —        —  

Asset-backed securities

     205      —        2      203
                           

Total held-to-maturity securities

   (Won) 10,963    (Won) 47    (Won) 110    (Won) 10,900
                           

(1)

Includes debt securities issued by Korea Electric Power Corporation, which is controlled by the Korean government, in the amount of (Won)16 billion as of December 31, 2004, (Won)14 billion as of December 31, 2005 and (Won)48 billion as of December 31, 2006.

 

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(2)

Includes debt securities issued by the Bank of Korea, the Korea Development Bank and the Industrial Bank of Korea in the aggregate amount of (Won)10,206 billion as of December 31, 2004, (Won)8,100 billion as of December 31, 2005 and (Won)6,667 billion as of December 31, 2006. These financial institutions are controlled by the Korean government.

(3)

Includes debt securities issued by Korea Electric Power Corporation, which is controlled by the Korean government, in the amount of (Won)30 billion as of December 31, 2004, (Won)90 billion as of December 31, 2005 and (Won)90 billion as of December 31, 2006.

(4)

Includes debt securities issued by the Bank of Korea, the Korea Development Bank and the Industrial Bank of Korea in the aggregate amount of (Won)1,144 billion as of December 31, 2004, (Won)3,476 billion as of December 31, 2005 and (Won)2,042 billion as of December 31, 2006. These financial institutions are controlled by the Korean government.

Derivatives Trading

Until the full-scale launch of our derivative operations in mid-1999, we had been engaged in limited volumes of derivatives trading, mostly on behalf of our customers. Since then, our trading volume significantly increased from (Won)103,608 billion in 2004 to (Won)112,785 billion in 2005 and to (Won)149,438 billion in 2006. Our net trading revenue from derivatives and foreign exchange contracts for the year ended December 31, 2004, 2005 and 2006 was (Won)298 billion, (Won)268 billion and (Won)248 billion, respectively.

We provide and trade a range of derivatives products, including:

 

   

Won interest rate swaps, relating to Won interest rate risks;

 

   

cross-currency swaps, relating to foreign exchange risks, largely for Won against U.S. dollars;

 

   

foreign exchange forwards, swaps and options, relating to foreign exchange risks; and

 

   

equity options on the KOSPI index.

To provide more sophisticated and complete treasury risk management services to our clients, we entered into a business alliance with Australia’s Macquarie Bank in December 1998. Macquarie Bank, established in 1969, is a leading provider of financial services offering a full range of investment banking, commercial banking and retail financial services globally. Through this alliance, we were able to combine Macquarie Bank’s derivatives expertise, risk management systems and methodologies with our established local infrastructure and strong market presence.

Our derivative operations focus on addressing the needs of our corporate clients to hedge their risk exposure and to hedge our risk exposure that results from such client contracts. We also engage in derivative trading activities to hedge the interest rate and foreign currency risk exposure that arise from our own assets and liabilities. A substantial portion of these hedge-purposed derivative contracts, however, do not qualify for hedge accounting under U.S. GAAP and are consequently treated as trading derivatives. In addition, we engage in proprietary trading of derivatives within our regulated open position limits.

 

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The following shows the estimated fair value of our derivatives and foreign exchange spot contracts as of December 31, 2004, 2005 and 2006:

 

     As of December 31,
     2004    2005    2006
     Estimated
fair
value
assets
   Estimated
fair
value
liabilities
   Estimated
fair
value
assets
   Estimated
fair
value
liabilities
   Estimated
fair
value
assets
   Estimated
fair
value
liabilities
     (in billions of Won)

Foreign exchange spot contracts

   (Won) 8    (Won) 5      —        —        —        —  

Foreign exchange derivatives

     1,998      1,846    (Won) 906    (Won) 820    (Won) 968    (Won) 958

Interest rate derivatives (1)

     323      372      234      245      177      219

Equity derivatives

     72      74      62      62      26      46

Others

     —        —        —        —        —        —  
                                         

Total

   (Won) 2,401    (Won) 2,297    (Won) 1,202    (Won) 1,127    (Won) 1,171    (Won) 1,223
                                         

(1)

Includes those for trading purposes and hedging purposes.

The following table shows the unrealized gains and losses of derivatives held or issued for hedging purposes that qualified for hedge accounting under U.S. GAAP, as of December 31, 2004, 2005 and 2006:

 

     As of December 31,
     2004    2005    2006
     Unrealized
gains
   Unrealized
losses
   Unrealized
gains
   Unrealized
losses
   Unrealized
gains
   Unrealized
losses
     (in billions of Won)

Interest rate derivatives (1)

   (Won) 10    (Won) 10    (Won) 52    (Won) 52    (Won) 2    (Won) 2
                                         

Total

   (Won) 10    (Won) 10    (Won) 52    (Won) 52    (Won) 2    (Won) 2
                                         

(1)

Includes the unrealized gains and losses of the underlying hedged items.

Asset Securitization Transactions

We are active in the Korean asset-backed securities market. Based on our diverse experience with respect to product development and management capabilities relating to asset securitization, we offer customers a wide range of financial products to reinforce our position as a leading bank with respect to the asset securitization market. We were involved in asset securitization transactions with an initial aggregate issue amount of (Won)9,214 billion in 2004, (Won)6,865 billion in 2005 and (Won)6,738 billion in 2006, of which (Won)5,517 billion, (Won)4,671 billion and (Won)3,222 billion, respectively, were public offerings of asset-backed securities. Most of these securities were sold to institutional investors through Korean securities houses.

Call Loans

We make call loans and borrow call money in the short-term money market. Through December 31, 2006, call loans were defined as short-term lending among banks and financial institutions either in Won with maturities of 90 days or less or in foreign currencies with maturities of 90 days or less. Typically, call loans have maturities of one day. As of December 31, 2006, we had made call loans of (Won)1,237 billion and borrowed call money of (Won)168 billion, compared to (Won)1,713 billion and (Won)1,254 billion, respectively, as of December 31, 2005. Starting in 2006, we also include as call loans foreign currency lending among banks and financial institutions with maturities of 90 days or less.

 

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Investment Banking

We have focused on selectively expanding our investment banking activities in order to increase our fee income and diversify our revenue base. The main focus of our investment banking operations is project finance and financial advisory services. Our principal investment banking services include:

 

   

project finance and financial advisory services for social overhead capital projects such as highway, port, power, water and sewage projects;

 

   

financing and financial advisory services for real estate development projects; and

 

   

structured finance and venture financing.

In 2006, under Korean GAAP, we generated investment banking revenue of (Won)143 billion, consisting of (Won)42 billion of interest income and (Won)101 billion of fee income.

International Banking

We engage in various international banking activities, including foreign exchange services and derivatives dealing, import and export-related services, offshore lending, syndicated loans and foreign currency securities investment. These services are provided primarily to our domestic customers and overseas subsidiaries and affiliates of Korean corporations. We also raise foreign currency funds through our international banking operations. Since the Korean financial crisis, which began in late 1997, we have focused on minimizing the risk of our existing foreign currency assets and maximizing the recovery ratio of non-performing assets while selectively providing financing to and making investments in overseas subsidiaries of Korean companies.

The table below sets forth certain information regarding our foreign currency assets and borrowings:

 

     As of December 31,
     2004    2005    2006
     (in millions of US$)

Total foreign currency assets

   US$ 5,465    US$ 7,435    US$ 10,211

Foreign currency borrowings:

        

Long-term borrowings

     1,485      1,714      3,771

Short-term borrowings

     730      1,830      2,088
                    

Total borrowings

   US$ 2,215    US$ 3,544    US$ 5,859
                    

The table below sets forth our overseas subsidiaries and branches currently in operation as of December 31, 2006:

 

Business Unit(1)

   Location

Subsidiaries

  

Kookmin Bank Hong Kong Ltd.

   Hong Kong

Kookmin Bank International Ltd.

   United Kingdom

Branches

  

Kookmin Bank, Tokyo Branch

   Japan

Kookmin Bank, Auckland Branch

   New Zealand

Kookmin Bank, New York Branch

   United States

(1)

Does not include subsidiaries and branches in liquidation or dissolution.

Our overseas branches and subsidiaries principally provide Korean companies and nationals in overseas markets with trade financing, local currency funding and foreign exchange services, in conjunction with the operations of our headquarters. In June 2007, we opened a representative office in Almaty, Kazakhstan.

 

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In December 2003, we invested approximately 121 million Singapore dollars for an approximately 25% interest in Sorak Financial Holdings, which was originally owned by Temasek Holdings, the Singapore government’s investment vehicle. We made this investment as part of a consortium with Temasek and other parties that was formed to bid for a majority interest in Bank Internasional Indonesia, an Indonesian commercial bank, being auctioned by the Indonesian Bank Restructuring Agency. With the capital contributions made by the consortium members, Sorak Financial Holdings acquired an approximately 57% interest in Bank Internasional Indonesia. As a member of the consortium, we participate in the management of Bank Internasional Indonesia.

Trustee and Custodian Services Relating to Investment Trusts and Other Functions

We act as a trustee for 40 asset management companies, which invest in investment assets using funds raised by the sale of beneficiary certificates of investment trusts to investors. We also act as custodian, settlement and clearing agent and fund administrator for 68 financial institutions with respect to various investments. We receive a fee for acting in these capacities and generally perform the following functions:

 

   

holding assets for the benefit of the investment trusts or institutional investors;

 

   

receiving and making payments in respect of such investments;

 

   

executing trades in respect of such investments on behalf of the investment trust or institutional investors, based on instructions from the relevant asset management company or such investors;

 

   

in certain cases, authenticating beneficiary certificates issued by the investment trust and handling settlements in respect of such beneficiary certificates;

 

   

clearing and settlement in the domestic and foreign securities markets;

 

   

providing foreign exchange services for overseas investment and foreign investors; and

 

   

providing fund-related administration and accounting services.

For the year ended December 31, 2006, our fee income from our trustee and custodian services was (Won)21 billion and revenues collected as a result of administration of the underlying investments were (Won)7 billion.

Other Businesses

Trust Account Management Services

Money Trust Management Services

We provide trust account management services for unspecified money trusts, which are trusts the assets of which we generally have broad discretion in investing. We receive fees for our trust account management services consisting of basic fees that are based upon a percentage of the net asset value of the assets under management and, for certain types of trust account operations, performance fees that are based upon the performance of the trust account operations. In 2006, our basic fees ranged from 0.1% to 2.0% of total assets under management depending on the type of trust account. We also charge performance fees with respect to certain types of trust account products. We receive penalty payments when customers terminate their trust accounts prior to the original contract maturity.

We currently provide trust account management services for 24 types of money trusts. The money trusts we manage are generally trusts with a fixed maturity. Approximately half of our money trusts also provide periodic payments of dividends which are added to the assets held in such trusts and not distributed.

Under Korean law, the assets of our trust accounts are segregated from our banking account assets and are not available to satisfy the claims of any of our potential creditors. We are, however, permitted to deposit surplus funds generated by trust assets into our banking accounts.

 

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As of December 31, 2006, the total balance of our money trusts (under Korean GAAP) was (Won)9,627 billion. As for unspecified money trust accounts, we have investment discretion over all money trusts, which are pooled and managed jointly for each type of trust account. Specified money trust accounts are established on behalf of individual customers who direct our investment of trust assets.

The following table shows the balances of our money trusts by type as of the dates indicated as determined in accordance with Korean GAAP. Under U.S. GAAP, we historically did not consolidate money trust accounts in our financial statements or recognized the acquisition of such accounts in accordance with the purchase method of accounting due to the fact that these are not our assets but customer assets. As more fully discussed in Note 9 to our financial statements, however, beginning in 2004, we began consolidating money trusts for which we guaranteed both the principal and a fixed rate of interest (as described below) under U.S. GAAP. Under Korean GAAP, we consolidate money trusts for which we guaranteed the principal amount invested as well as those for which we guaranteed both the principal and a fixed rate of interest.

 

     As of December 31,
     2004    2005    2006
     (in billions of Won)

Principal and interest guaranteed trusts

   (Won) 0.3    (Won) 0.3    (Won) 0.3

Principal guaranteed trusts

     3,162      3,188      3,301

Performance trusts (1)

     3,867      4,218      6,326
                    

Total

   (Won) 7,029    (Won) 7,406    (Won) 9,627
                    

(1)

Non-guaranteed trusts.

The balance of our money trusts increased 37.0% between December 31, 2004 and December 31, 2006.

As of December 31, 2006, the trust assets we managed consisted principally of securities investments and loans from the trust accounts. As of December 31, 2006, under Korean GAAP, our trust accounts had invested in securities in the aggregate amount of (Won)7,939 billion, of which (Won)7,268 billion was debt securities. Securities investments consist of government-related debt securities, corporate debt securities, including bonds and commercial paper, equity securities and other securities. Loans made by our trust account operations are similar in type to the loans made by our bank account operations. As of December 31, 2006, under Korean GAAP, our trust accounts had made loans in the principal amount of (Won)404 billion (excluding loans from the trust accounts to our banking accounts of (Won)950 billion), which accounted for 4.0% of our money trust assets. Loans by our money trusts are subject to the same credit approval process as loans from our banking accounts. As of December 31, 2006, substantially all of loans from our money trust accounts were collateralized or guaranteed.

Our money trust accounts also invest, to a lesser extent, in equity securities, including beneficiary certificates issued by asset management companies. On a Korean GAAP basis, as of December 31, 2006, equity securities in our money trust accounts amounted to (Won)671 billion, which accounted for 6.7% of our total money trust assets. Of this amount, (Won)598 billion was from specified money trusts and (Won)73 billion was from unspecified money trusts.

We currently continue to offer pension-type money trusts that provide a guarantee of the principal amount of the investment. On a Korean GAAP basis, as of December 31, 2006, the balance of the money trusts for which we guaranteed the principal was (Won)3,301 billion.

If the income from a money trust for which we provide a guarantee is less than the amount of the payments we have guaranteed, we will need to pay the amount of the shortfall with funds from special reserves maintained with respect to trust accounts followed by basic fees from that money trust and funds from our general banking operations. In 2004, 2005 and 2006 we made no significant payments from our banking accounts to cover

 

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shortfalls in our guaranteed trusts. On a Korean GAAP basis, we derived trust fees with regard to trust account management services (including those fees related to property trust management services) of (Won)102 billion in 2004, (Won)121 billion in 2005 and (Won)78 billion in 2006.

The Indirect Investment Asset Management Business Act, which applies to unspecified money trusts, took effect in January 2004. Under that law, a bank is not permitted to offer unspecified money trust products, which was a core product in our trust business, after July 2004 (except under certain limited circumstances) and is required to qualify as an asset management company in order to manage any newly offered unspecified money trust products. See “—Principal Regulations Applicable to Banks—Trust Business.” Because we did not qualify as an asset management company under the Indirect Investment Asset Management Business Act, since July 2004, we have continued to directly manage only trust products sold before July 2004. Trust products sold after July 2004 are managed by KB Asset Management. We believe that we can leverage our extensive sales network in connection with KB Asset Management’s unspecified money trust operations.

Property Trust Management Services

We also offer property trust management services, where we manage non-cash assets in return for a fee. Non-cash assets include mostly securities, but can also include other liquid receivables and real estate. Under these arrangements, we render custodial services for the property in question and collect fee income in return.

In 2006, our property trust fees ranged from 0.001% to 0.3% of total assets under management depending on the type of trust accounts. As of December 31, 2006, the aggregate balance of our property trusts decreased to (Won)6,631 billion, compared to (Won)9,854 billion as of December 31, 2005.

The property trusts are not consolidated within our U.S. GAAP financial statements.

Investment Trust Management

We offer investment trust products to customers and manage the funds invested by them in investment trusts, through our subsidiary, KB Asset Management, which is 80% owned by us and 20% owned by ING Insurance International B.V. As of December 31, 2006, KB Asset Management had (Won)15,637 billion of assets under management.

Management of the National Housing Fund

We manage the operations of the National Housing Fund. The National Housing Fund provides financial support to low-income households in Korea by providing mortgage financing and construction loans for projects to build small-sized housing. The operations of the National Housing Fund include providing and managing National Housing Fund loans, issuing National Housing Fund bonds and collecting subscription savings deposits.

In return for managing the operations of the National Housing Fund we receive a monthly fee, calculated based on activity levels for the relevant month. In 2006, we received total fees of (Won)172 billion for managing the National Housing Fund, compared to (Won)180 billion in 2005.

The financial accounting for the National Housing Fund is entirely separate from our financial accounting, and the non-performing loans and loan losses of the National Housing Fund, in general, do not impact our financial condition. Regulations and guidelines for managing the National Housing Fund are issued by the Minister of Construction and Transportation pursuant to the Housing Act.

In November 2002, the Ministry of Construction and Transportation designated two other financial institutions to, together with us, manage the Fund with a view to diversifying its management. In February 2003, the Ministry of Construction and Transportation changed the basis of calculating fees related to the National

 

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Housing Fund and, in March 2006, appointed an independent consultant to advise on further changes to the basis of calculating such fees and the designation of institutions to manage the National Housing Fund. In November 2003, the Ministry of Construction and Transportation strengthened existing regulations to provide for liability of managers of the National Housing Fund, where they had clear responsibility for non-performing National Housing Fund loans or where losses resulted to the National Housing Fund due to negligent management.

Bancassurance

The Korean government’s liberalization of the bancassurance market in Korea has allowed us to offer insurance products of other institutions since September 2003. We currently market a wide range of bancassurance products and hope to develop additional fee-based revenues by expanding our offering of these products in the future.

Currently, our bancassurance business has alliances with 15 life insurance companies and nine non-life insurance companies and offers 46 different products through our branch network. These products are composed of 26 types of life insurance policies such as annuities, savings insurance and variable life insurance, and 20 types of non-life insurance products. In 2006, our commission income from our bancassurance business amounted to (Won)154.7 billion.

Lottery Business

We have been designated by the government as a “lottery operator” and have been permitted to conduct ticket sales, marketing and sales network management in connection with two lotteries, the “Housing Lottery” and the “Lotto 6/45,” since 1969 and 2002, respectively. These lotteries are owned by the Korean government. In 2006, we received (Won)13 billion in fees in connection with managing lottery prize payouts and marketing activities.

Other Distribution Channels

The following table sets forth information under Korean GAAP, for the periods indicated, on the number of users and transactions and the fee revenue of the other services provided to our retail and corporate customers, which are discussed below:

 

     For the year ended December 31,
     2004    2005    2006

Phone banking:

        

Number of users (1)

     1,573,505      1,678,791      1,774,717

Number of transaction (thousands)

     285,892      308,714      309,174

Fee revenue (in millions of Won)

   (Won) 18,021    (Won) 20,770    (Won) 19,672

Internet banking:

        

Number of users (1)

     3,223,671      4,337,349      6,050,196

Number of transactions (thousands)

     566,192      903,769      1,099,105

Fee revenue (in millions of Won)

   (Won) 19,296    (Won) 25,722    (Won) 29,850

(1)

Users are defined as persons who had recorded a transaction within the past six months (excluding overlapping and inactive customers).

In March 2007, we reduced or waived many of the fees we charge on our banking services, in response to customer demand. Specifically, we reduced or waived our fees on fund transfers through our Internet, mobile and telephone banking services, as well as on transfers and after-hour withdrawals through ATMs. We also reduced our wire transfer fees and eliminated the fees we charge on issuance of bankers’ checks and certain tax-related statements. These measures may result in a significant reduction in our banking-related fee income.

 

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Phone Banking

We launched our telephone banking services in 1991, allowing customers to conduct a number of types of transactions by telephone. We offer a variety of services, including inter-account fund transfers, balance and transaction inquiries, credit card transaction inquiries and customer service inquiries. We also have call centers, which we primarily use to:

 

   

advise clients with respect to deposits, loans and credit cards and to provide our customers a way to report any emergencies with respect to their accounts;

 

   

allow our customers to conduct transactions with respect to their accounts, such as transfers or payments, opening or closing accounts, processing loans through automated systems, conducting credit card transactions and offering lottery-related services;

 

   

conduct telemarketing to our customers or potential customers to advertise products or services through phone, fax or text messaging; and

 

   

provide automated banking services, mobile services or other services relating to affinity programs.

Internet Banking

We began to offer a variety of services over the Internet beginning in 1999. Our goal is to consolidate our position as a market leader in on-line banking. Our Internet banking services currently include:

 

   

Basic Banking Services—these include all of the banking services offered through our telephone banking services, including funds transfers, balance and transaction inquiries, credit card transaction inquiries, pre-set automatic transfers and product inquiries;

 

   

Processing of Loan Applications—we quickly process and approve on-line loan applications; and

 

   

Electronic Certification—we offer an electronic certification service, which permits Internet users to authenticate transactions on a confidential basis through digital signatures.

Mobile Banking

Mobile banking services allow customers to use mobile phones or PDAs (Personal Digital Assistants) to make inter-account transfers and balance and other transaction inquiries. There are currently three mobile phone service providers in Korea, SK Telecom, KT Freetel, and LG Telecom, and we provide our services in association with all three. Our mobile banking services currently include:

 

   

Basic Banking Services—these include fund transfers and balance and transaction inquiries;

 

   

Mobile Stock Trading—mobile banking customers can use their mobile phone to trade stocks; and

 

   

Mobile Lottery and Application for Housing—we offer a mobile lottery purchasing service (Instant Lotto, Housing Lotto, Keno) and mobile submissions of applications for housing.

Other Channels

We provide cash management services, which include automatic transfers, connection services to other financial institutions, real-time firm banking, automatic fund concentration and transmittal of trading information. We have continued to develop our firm banking services and, as of December 31, 2006, we provided cash management services to over 1,300 large corporations and small- and medium-sized enterprises.

 

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Competition

We compete principally with other nationwide commercial banks in Korea, but we also face competition from a number of additional sources including regional banks, development banks, specialized banks and branches of foreign banks operating in Korea and installment finance corporations for mortgage loan products. We also compete for customer funds with other types of financial service institutions, including savings institutions (such as mutual savings and finance companies and credit unions and credit cooperatives), investment institutions (such as merchant banking corporations) and life insurance companies. Competition in the domestic banking industry is generally based on the types and quality of the products and services offered, including the size and location of retail networks, the level of automation and interest rates charged and paid.

Competition has increased significantly in our traditional core businesses, retail banking, small- and medium-sized enterprise banking and credit card lending, as a result of other commercial banks reducing their exposure to large corporations in light of recent financial difficulties that they experienced, contributing to some extent to the asset quality deterioration in retail and small- and medium-sized loans. As a result, our margins on lending activities may decrease in the future.

In addition, general regulatory reforms in the Korean banking industry, accelerated by Korea’s economic difficulties since late 1997 and the Korean government’s commitments to the International Monetary Fund, have increased competition among banks and financial institutions in Korea. Among these reforms was the lifting of the regulatory restrictions on mortgage lending and housing deposit taking activities that had prevented the other commercial banks in Korea from competing directly with H&CB in providing mortgage finance products. Increased competition in the mortgage sector has also contributed to lower margins from our mortgage lending activities. As the reform of the financial sector continues, foreign financial institutions, some with greater resources than us, have entered, and may continue to enter, the Korean market either by themselves or in partnership with existing Korean financial institutions and compete with us in providing financial and related services.

In addition, the Korean commercial banking sector is undergoing significant consolidation. A number of significant mergers and acquisitions in the industry have taken place in Korea during the last five years, including the establishment of financial holding companies, which have reduced the number of nationwide commercial banks in Korea from 16 as of December 31, 1997, to seven banks and three financial holding companies as of December 31, 2006. Furthermore, a number of significant mergers and acquisitions in the industry have taken place in Korea over the last few years, including the acquisition of Koram Bank by an affiliate of Citibank in 2004 and Standard Chartered Bank’s acquisition of Korea First Bank in April 2005, as well as Chohung Bank’s merger with Shinhan Bank in April 2006. Merger and acquisition activity in the Korean commercial banking sector may continue, and we intend to review potential acquisition opportunities as they arise. We cannot guarantee that we will not be involved in any future mergers. In addition, some of the banks resulting from these mergers may, by virtue of the increased size, provide significantly greater competition than what exists at present.

For additional information, you should read the section entitled “Item 3D. Risk Factors—Risks relating to competition.”

Information Technology

Our mainframe-based banking and credit card IT systems are designed to ensure continuity of services even where there is a failure of the host data center due to a natural disaster or other accidents by utilizing backup systems in disaster recovery data centers. In addition, through the implementation of Parallel Sysplex, a “multi-CPU system”, our bank and credit card systems are designed and operated to be able to process transactions without material interruption in the event of CPU failure.

 

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The integrity of our IT systems, and their ability to withstand potential catastrophic events (such as natural calamities and internal system failures), is crucial to our continuing operations. We currently test our disaster recovery systems on a quarterly basis. For additional information, see “Item 11. Quantitative and Qualitative Disclosures about Market Risk—Operational Risk Management.”

We believe that continuous improvement of our IT system is crucial in supporting our operations management and providing high-quality customer service. Accordingly, we plan to upgrade and improve our system by taking the following initiatives:

 

   

developing our next generation banking system, beginning in 2007 with a target completion in 2010, which includes seven projects including the reconstruction of our core banking system, enterprise data warehouse system and Internet banking system; and

 

   

strengthening our system security by expanding our IT security organization with additional security experts, centralizing the control and management of system security and improving our firewall and virus prevention system.

Timely offering of IT services to support business opportunities is important in retaining our competitiveness. We developed and successfully implemented the following IT services in mid-2006:

 

   

an expanded and upgraded bank-wide, integrated customer relationship management system to help identify potential and cross-marketing opportunities by providing comprehensive customer information including transaction history; and

 

   

various other IT systems and services, including further development of our retirement pension system, a “cyber branch” to provide customized banking services for corporate customers and new infrastructure to support large-scale real estate subscription businesses.

We have also begun the development of a “Capital Markets Business System” that will support the sales of complex financial products.

In 2006, we spent approximately (Won)368 billion for our IT systems, including expenses related to upgrades and stability enhancement for our IT systems and development of next generation banking systems. As of December 31, 2006, we employed a total of approximately 690 full-time employees in our IT operations.

Assets and Liabilities

The tables below set out selected financial highlights regarding our banking operations and individual assets and liabilities. Data in these tables do not include information with respect to operations that we have classified as discontinued operations as of and for the year ended December 31, 2002 under U.S. GAAP.

Loan Portfolio

As of December 31, 2006, our total loan portfolio increased to (Won)151,403 billion compared to (Won)138,012 billion at December 31, 2005. As of December 31, 2006, 94.8% of our total loans were Won-denominated loans.

 

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Loan Types

The following table presents loans by type for the periods indicated. Except where we specify otherwise, all loan amounts stated below are before deduction of allowance for loan losses. Total loans reflect our loan portfolio, including past due amounts.

 

     As of December 31,
     2002    2003    2004    2005    2006
     (in billions of Won)

Domestic:

              

Corporate

              

Commercial and industrial (1)

   (Won) 40,072    (Won) 41,096    (Won) 38,427    (Won) 39,636    (Won) 48,183

Construction

     6,385      6,061      4,459      5,025      6,504

Lease financing

     —        —        —        —        —  

Other corporate

     1,045      742      771      1,496      1,409

Retail

              

Mortgage and home equity

     46,195      52,477      57,965      59,143      63,982

Other consumer

     28,066      28,727      25,963      23,114      21,589

Credit cards

     22,643      15,322      9,421      8,369      8,955
                                  

Total domestic

     144,406      144,425      137,006      136,783      150,622
                                  

Foreign:

              

Corporate

              

Commercial and industrial

     1,426      1,433      1,118      1,229      781
                                  

Total foreign

     1,426      1,433      1,118      1,229      781
                                  

Total gross loans

   (Won) 145,832    (Won) 145,858    (Won) 138,124    (Won) 138,012    (Won) 151,403
                                  

(1)

Commercial and industrial loans include (Won)165 billion, (Won)3 billion, (Won)335 billion, (Won)222 billion and (Won)400 billion of loans to Korean government and government related agencies (including the Korea Deposit Insurance Corporation) as of December 31, 2002, 2003, 2004, 2005 and 2006, respectively.

Loan Concentrations

We limit our exposure to any single borrower to 10% of our total Tier I and Tier II capital, depending on their rating under our credit scoring system. We also limit our exposure to any single chaebol to 20.0% of our total Tier I and Tier II capital (less any capital deductions).

 

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20 Largest Exposures by Borrower

As of December 31, 2006, our 20 largest exposures totaled (Won)21,370 billion and accounted for 11.6% of our total exposures. The following table sets forth, as of December 31, 2006, our total exposures to these top 20 borrowers:

 

Company

  Loans  

Equity
securities

 

Debt
securities

 

Guarantees
and
acceptances

 

Total
exposures

  Amounts
classified as
impaired
loans
  Won
currency
  Foreign
currency
         
    (in billions of Won)

The Bank of Korea

  (Won) 0   (Won) 0   (Won) 0   (Won) 8,710   (Won) 0   (Won) 8,710   (Won) 0

Hyundai Heavy Industries

    0     0     2     5     1,472     1,479     0

Industrial Bank of Korea

    0     2     2     1,167     0     1,171     0

Korea Deposit Insurance Corporation

    0     0     0     1,085     0     1,085     0

LG Card

    59     0     821     0     0     880     59

Woori Bank

    70     353     0     456     0     879     0

Korea National Housing Corporation

    644     0     0     220     0     864     0

Shinsegae

    300     393     2     10     0     705     0

The Korea Development Bank

    13     0     0     660     0     673     0

LG Electronics

    2     539     1     56     0     598     0

Samsung Electronics

    6     240     23     0     285     554