The financial supervisory commission, urging faster financial sector reforms, said the government would support healthy banks but would force ailing banks to change their management, merge with other banks or simply close.

President Kim Dae-jung also stressed the importance of mergers and acquisitions (M&As) among financial institutions.

"Our financial companies must learn a lesson from the megamergers in the US banking system, and study the possibility of M&As to make them more solid and powerful," Kim said. "The government has to extend incentives to encourage mergers."

The commission and Kim were heralding the beginning of the long-awaited blood-letting in South Korea's financial sector.

The authorities have already started to privatise two ailing government-owned banks, Seoulbank and Korea FirstBank, and have closed or suspended the business of 16 of the country's 30 merchant banks.

But much more restructuring is now expected.

"Korea has set the stage for dramatic financial reforms..."said Yun Seok, research head at Credit Suisse First Boston. "I believe the government is determined to pursue the big shakeout. And in fact, it has no alternatives."

Long-dormant problems in South Korea's outdated financial system helped push the country to the brink of default late last year and forced it to accept a record-breaking $58.35 billion package of bailout loans arranged by the International Monetary Fund. The deal that secured the IMF loans demanded financial-sector reforms, which are only now beginning with banks but are expected to soon move on to other financial institutions. "Many financial institutions have been lined up for tough restructuring," said banking analyst Kim Chul-jung at Ssangyong Securities. "We will soon hear about serious troubles in leasing companies, life insurers and investmenttrust companies, and their mergers and takeovers," he said. Two major securities houses defaulted earlier this year. Although they hoped for takeovers, their prospects look gloomy. "It's the tip of an iceberg," Kim Chul-jung said. The Korea Institute of Finance warned that the number of non-performing loans in banks would increase and more securities houses would fail. It also said a few domestic merchant banks, which specialise in arranging finance, should end up transformed into investment banks. Yun at Credit Suisse expected that only six or seven of the 26 commercial banks would survive the shakeout. "Smaller banks will face business suspension and their assets are expected to transfer to a bridge bank," Yun said. "I expect no radical shakeout in the major five commercial banks as the government will fear any massive run on those banks." The government is expected to set up a bridge bank to facilitate the restructuring. Analysts expect the bridge bank to take over some of the assets of insolventcommercial banks. In a sign of the impending shakeout, the government is due to announce on Monday which foreign investment banks will arrange the privatisation of Korea First Bank and Seoulbank. Analysts said only a handful of foreign investors would show interest in Korean banks because of difficulty of cutting staff, the possibility of more bad loans and the nation's sentiment against foreign investment.