South Korea’s banks have been suffering wide profit swings. Park Sang-soo reports from Seoul on their efforts to find alternative sources of income to beef up their profitability.

On the surface, the South Korean banking sector appears to be continuing its slow but steady recovery from the 1997 Asian financial crisis, with banks’ assets ballooning and asset quality improving sharply for the past few years.

Banks have enjoyed a decent commission income through their credit card businesses in addition to interest income from lending to households, but suffered a further wider swing in profits last year because of overdue credit card payments and cash advances.

Fluctuating revenues

This indicates that their ability to respond quickly and appropriately to economic downturns and other events has not improved to the extent that a stable earnings stream is guaranteed. South Korean banks’ heavy reliance on interest income, coupled with relatively high fundraising costs and a low capital base, still poses the risk of wide fluctuations in revenues, which is now prodding them to find alternative income sources by staying away from their customary interest income-based business. For now, one of the most important tasks facing South Korean banks that are struggling to rein in lending and clean up messy balance sheets is to rearrange their profit structure.

The latest data from the Financial Supervisory Service, the country’s financial watchdog, shows how fragile and shaky South Korean banks’ profitability is. Kookmin Bank and 18 other South Korean lenders had a 63% drop in combined earnings last year to Won1860bn because of increased provisions against loans given to businesses and household debts. In 2003 alone, the banking sector newly set aside a total of Won2770bn ($240m) in provisions against loans to corporate customers alone, and an additional Won8190bn against overdue household loans and credit card payments, which eroded banks’ bottom lines.

Profitability prospects

The general view is that profitability at Korean banks will rise more slowly than before, as falling credit costs on household and card lending outweigh a possible rise in defaulted loans to small and medium-sized enterprises. The sector racked up Won168,000bn in combined earnings during the first three months of the year, a sharp increase from last year’s Won4990bn first-quarter profit.

Such scenarios, however, basically depend on how effectively and quickly banks can rein in the pace of lending and clean up their messy credit exposure. Banks’ profitability can drastically worsen any time because South Korean banks’ revenue structures, according to experts, are too simple.

Banks’ lending to households and companies made up 59% of total assets in the first quarter of 2003, sharply up from 36.4% in 1998 and 47.03% in 2000, according to a report from the Korea Institute of Finance (KIF).

Banks’ net interest income against operating income was 73% in 1999. The ratio fell to 67% in the first quarter of 2003, but it is showing a sign of rising again, as banks’ lending to households increased sharply over the past years, the report said.

“They [banks] increasingly realise that they can no longer generate stable earnings just with lending business. The business environment is drastically changing,” says Lee Jae-yeon, a senior researcher at the KIF.

The loan-deposit interest spread, one of the biggest income sources, has been kept at around three percentage points over the past several years but the gap is narrowing. Added to this, incomes from card lending or cash advances, classified as non-interest revenues on banks’ income statements, drastically fell as banks reined in the pace of lending and more cardholders defaulted on borrowings.

Shift of focus

Sensing this, South Korean banks are now shifting their focus onto fee-based or non-banking business from the traditional banking service of lending out money.

Their move toward non-interest income sources is gaining momentum, in particular after Citigroup’s Won3100bn purchase of Koram Bank last month. They are braced for likely increased competition and diversified banking services from the US-based financial group through Koram Bank’s nationwide business network.

Competition is already heating up among local players to hire well-trained financiers for the private banking service to beef up their own wealth management service, a largely fee-based business. Private banking service, they believe, will help reduce banks’ dependence on interest as a source of revenue.

“Wooing high-net-worth individuals and multiplying their assets will bring in high commission income for banks. In other words, it is good both for us and our customers,” says Chungjin-seop, a general manager at Kookmin Bank’s private banking/asset management business unit.

Private banking promise

In fact, the private banking service is not new to local players. Citigroup’s branch office in Seoul introduced the service to the nation for the first time in 1991. As of end-July last year, 17 local banks offered private banking services to wealthy customers.

Banks believe that the local market for private banking also has promise. In a population of 47 million, more than 50,000 South Koreans had assets exceeding $1m in 2002, according to a study by Merrill Lynch and Cap Gemini Ernst & Young. A report by the Boston Consulting Group in 2000 also estimated that South Korea’s private banking market would rise to Won2500bn-2900bn by next year.

Through better business networks across the country, South Korean banks believe that they will also be able to gain more profits from asset management business and make their banking and asset management products competitive to meet Citigroup’s challenge.

They are already on the move to beef up their asset management business through collaboration with or acquisitions of mid-size and major securities brokerages or asset management companies.

KIF’s Lee says with deregulation lowering barriers to entry in Korea’s financial services industries, some domestic banks are stepping up their moves to diversify their revenue sources. “They will be able to expect a kind of synergy effect by combining asset management business and lending business.”

Kookmin Bank, which provides banking services to half of Korea’s 48 million people, is one of the potential bidders for the nation’s two largest trust companies, Korea Investment & Securities and Daehan Investment & Securities, in a bid to capitalise on its sales network of more than 1100 branches nationwide.

“Our target is to sell asset management products to our banking customers, which will give us risk-fee commission incomes,” says Kookmin Bank’s Chung. “Large-sized banks are well-positioned to serve prominent players in asset management as they have strength in terms of distribution as well as brand image.” Kookmin has sold Won10,000bn in asset management products to customers over the past five years.

Standard & Poor’s Ratings Services also echoed such a view in a report on June 9, saying that the possible acquisition of non-banking financial institutions by several banks is likely to help diversify South Korean banks’ revenue sources. “Acquiring brokerages or ITMCs [investment trust management companies] may help banks increase their revenue sources from fees and commissions,” said S&P.

Banks believe that South Korea’s asset management market is poised to take off. The market peaked at Won260,000bn in 1999 before debt scandals at Daewoo Group triggered investment losses in funds for the first time. Customers had Won163,000bn invested in equity and fixed-income funds managed by asset management companies as of June 1.

As South Korean society ages, demand for asset management will also increase sharply. Korea is the fastest ageing society among member countries in the Organisation for Economic Co-operation and Development. The number of Koreans over the age of 65 is expected to double to 14% by 2019 from 7% in 2000, according to the Korea National Statistical Office.

Insurance route

Bancassurance is another strategic option for local banks. The South Korean government allowed banks, brokerages and other financial institutions to sell insurance policies from September last year. Local banks sold insurance polices worth Won19,000bn.

Last year, Hana Bank launched Hana Life, a joint venture with Germany’s Allianz AG, and in late 2002, Shinhan Financial Group set up a life insurer jointly with French insurer Cardif.

Kookmin launched its own life insurance subsidiary in June, KB Life, to solidify its footing in the fledgling bancassurance market. The bank has been the agent for life insurance policies developed by five life insurers, including Samsung Life and ING Life, under the bancassurance alliance. In April, it raked in Won5490bn in first-month premiums for bancassurance policies, accounting for 41.8 % of the new products sold by banks.


All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker

For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Request a demonstration to The Banker Database

Join our community

The Banker on Twitter