South Korea's banks have enjoyed mixed fortunes in 2014, a year that has seen high-profile scandals rock the country's largest lenders and in which innovative hybrid funding has characterised a spirit of innovation and growth among the country's small and regional players.

South Korea’s banking sector has not had an easy 12 months. Banking scandals, excess liquidity and the withdrawal of big foreign names, such as HSBC and Standard Chartered, from the country's retail banking market have made for a bumpy ride. The Japanese yen’s depreciation has also damaged the country's exporters this year and, in turn, the banks servicing them.

The largest South Korean banks – both private and public – are navigating these difficult times by upgrading their retail business at home and by expanding internationally. Smaller, regional banks, which have largely avoided the scandals that have dogged their larger rivals, are also growing quickly and venturing abroad.

South Korean bank funding is also becoming more sophisticated, with a number of institutions having either planned or already issued debut contingent convertible (CoCo) bonds. Some market participants argue that this is testament to banks’ renewed efforts to consolidate financial soundness amid a far from rosy environment.

Bad behaviour

South Korea’s largest consumer lender, Kookmin Bank, has been at the centre of a series of scandals, which included power struggles among its top executives as well as allegations of leaked customer data, embezzlement and illegal loans.

In August this year, the South Korean regulator, the Financial Supervisory Service (FSS), admonished 68 Kookmin officials for embezzling Won11.2bn ($11m) via fake national housing bond trades between 2010 and 2013, and for granting Won530bn-worth of illegal loans through the bank’s Tokyo branch.

Some considered the FSS measures tame, especially in comparison to those of its Japanese counterpart, which suspended Kookmin’s right to new business in Japan from September 4, 2014 until January 3, 2015. Tokyo’s Financial Services Agency (FSA) has found that Kookmin allocated loans to different companies in the same customer group to circumvent limits on concentration. The bank received cash payments booked as rebates in exchange. The FSA also deemed Kookmin’s protection against 'anti-social forces' (widely understood as organised crime) inadequate.

Similar allegations have been brought against Seoul-based lender Woori Bank, relating to activities at its Tokyo branches. The bank has been accused of receiving payments for granting loans to Japanese clients. An FSS official announced that Woori Bank managers had received about 10% of the loans in kickbacks. In February 2014, the bank said that its Tokyo branch provided Won60bn-worth of additional loans beyond certain customers’ credit limits, without securing additional collateral.

South Korea’s Fair Trade Commission also sent inspectors to Kookmin Bank, Woori Bank, Shinhan and Hana Bank in August 2014, to investigate potential collusion over interest rates – a particularly delicate issue in a country where household debt accounts for more than 150% of disposable income.

South Korea exports and imports

Fighting over profits

While some market participants blame poor monitoring within banks for these scandals, others say that South Korea’s banking sector is overbanked and has eroding lending standards.

“South Korea has very high corporate savings but very weak household domestic demand. It lacks productivity growth and has low service demand. This means banks are desperate to lend. They’ve been giving mortgages to everyone. They’ve been too aggressive,” says an Asia-Pacific senior economist, who commented on the condition of anonymity.

South Korea’s household savings rates have collapsed from 20% 20 years ago to a record low of 2% this year. Meanwhile, high profits have become a source of natural savings for corporates, meaning their lending demand is relatively low. Banks are therefore pushed to extending loans to individual clients, argues the senior economist.

“The lowest two-thirds of the population bracket by income has recently experienced the highest credit growth,” he says.

However, some South Korean bank officials disagree. “I don’t think the number of banks is an issue. Since the financial crisis in 1997, the country’s intense restructuring of financial institutions has reduced the number of banks from 32 in 1997 to 13, as of June this year,” says Hyung Joon Park, senior executive vice-president of planning and management at Seoul-based lender Hana Bank.

Hana Bank itself is in the process of merging with foreign exchange specialist Korea Exchange Bank (KEB) to capitalise on the latter’s international presence. Although slowed down by KEB trade unions, the merger could be finalised as soon as November 2014.

Numbers game

According to Dong-heon Lee, head of investor relations at Daegu-based DGB Financial Group, which owns regional bank Daegu Bank, South Korea is not overbanked, but rather it is over-regulated, and this has created inefficiencies and resulted in higher costs for private banks.

State ownership or influence still weighs on domestic financial markets. Mr Lee argues the state has historically imposed heavy fees or regulations on private banks to support the public sector. For instance, banks are unable to increase ATM customer fees due to a government-imposed ceiling.

However, the current administration has introduced deregulation measures, despite historically strong resistance towards such action. For example, the state has sanctioned hikes in loan-to-value and debt-to-income ratios to 70% and 60%, respectively. As customers increasingly turn to first-class lenders (commercial or regional banks) offering the lowest lending rates available, new business opportunities are arising for South Korea’s banks.

But, with Won1,000,000bn in household debt, easily available lending could cause market overheating. Sung-jin Bae, DGB’s investor relations assistant manager, is confident though that the Bank of Korea’s control over the policy rate is sufficient to manage the situation (the central bank recently cut policy rates by 25 basis points to 2% on October 15). 

Whether South Korea is overbanked is debatable, but most banks have been reducing their branch numbers in response to growing demand for internet or mobile banking.

Mr Park says that banks across the country are consolidating branch operations in the name of cost saving or efficiency, even if this implies losses in cross-selling potential. “Consumers tend to be more attracted to convenience rather than financial gains,” he says.

Shinhan Bank is also accommodating this new trend. "One of the bank's roles is to be a middleman figure who offers its customers the convenience they seek. Even we are becoming increasingly mobile since 94% of our entire transactions nowadays are not face to face but based on IT and mobile banking," says Young-Jin Lim, head of the wealth management group at Shinhan Bank.

Banks’ retail operations are also responding to South Korea’s ageing population, especially as older clients represent the country’s richest consumer segment. Shinhan Bank has developed retail products aimed at customers between 45 and 55 years of age. Elsewhere, in late September this year, Hana Bank launched the ‘Happiness Knowhow’ brand, which offers insurance products and retirement pensions for ageing clients.

New lines

In order to sustain profits amid a thorny banking environment, South Korean financial institutions are also diversifying into non-banking operations.

DGB Financial is currently acquiring Woori Aviva life insurance from Jung-gu-headquartered agricultural bank Nonghyup Bank, with whom DGB already has a memorandum of understanding. The deal should be finalised in either January or February 2015. The acquisition will help DGB improve its asset base while providing multi-purpose services and increasing the bank's customer pool. “DGB so far has had no life insurance arm. We see demand in the market for this type of service. Nowadays, you cannot survive if you only focus on banking,” says Mr Bae.

Expanding abroad is another solution to South Korea’s excess liquidity. With Western markets no longer the stalwart safe havens they used to be, and with Asian markets growing at a speed that neither Europe nor the US have experienced in decades, banks in Asia are generally looking within the continent to grow.

This inward-looking strategy has increased South Korean trade and, in turn, banking relationships with mainland China. “If I had to use one word to describe China for our business, it would be ‘awesome’,” says Mr Lim.

China is South Korea’s largest trading partner. Trade with China accounted for 20.8% of South Korea's total trade overseas between January and August this year.  According to the World Trade Organisation’s database, as of March 2014, China was the main recipient of South Korean exports (accounting for 24.5% of total exports) and accounts for most of Seoul’s imports (15.5% of overall imports).

Sino-Korean business agreements are also on the rise. Following Chinese president Xi Jinping’s visit to South Korea in July 2014, the two countries have agreed on building an offshore renminbi centre for currency trading in South Korea. The agreement includes the establishment of a won-yuan direct-trade market, the designation of a renminbi clearing bank for yuan currency trading and increasing the ceiling of the renminbi-qualified institutional investors quota up to Rmb80bn ($13bn).

Looking abroad

South Korean banks are expanding in mainland China. Indeed, China is Shinhan Bank’s top destination abroad. The bank recently won a settlement to use renminbi and yen in its mainland branches.

In Hana Bank’s case, it has been operating a subsidiary in Beijing since 2008, targeting both corporate and retail clients. It also made a 16.9% equity investment in the Chinese retail lender, Bank of Jilin. Despite a slowdown in China’s gross domestic product growth, Hana Bank is still keen on seeking to authenticate more of its services on the mainland and to tap the retail market further, says Mr Park.

Even South Korea’s smaller, regional banks, including DGB, are growing in China. As of now, the firm has only one branch in Shanghai – which was established in December 2012 – supporting small and medium-sized enterprises (SMEs) from the Daegu region investing in China.

Business opportunities for Daegu-based SMEs on the mainland are vast, with China needing to develop its water system, social infrastructure and services sector. Banks expanding abroad typically focus on trade finance services at first, as they follow their local firms internationally. DGB’s long-term strategy, though, is to customise its banking services by hiring more locals, for example, to increase its share of Chinese customers, says Mr Lee.

The Association of South-east Asian Nations (Asean) region is also essential to South Korean banks’ international expansion. DGB will set up its next international branch in Ho Chi Minh City, Vietnam, as soon as 2015. The bank is looking to service the 1700 Daegu-based firms already operating in Vietnam, especially in the textile industry. Forty-one Daegu textile companies have already been launched. Potential growth and trade relationships with Daegu firms make Indonesia DGB’s next objective, says Mr Bae.

Hana Bank has already strengthened its Indonesian footprint by merging with the South Korean foreign exchange specialist lender KEB. The new bank (KEB Hana Bank) combines the former’s strength in corporate banking with the latter’s retail operations. Hana Bank is also preparing documents to set up operations in Myanmar.

CoCos on a roll

Bank funding is also taking new turns in South Korea. A growing number of domestic firms are turning to CoCo bonds as a funding solution. Though a well-known and often used instrument among European banks, CoCos remain rare in Asia where only banks in Japan and a few in China and Singapore have stepped into the market.

In April this year, Woori Bank issued an ice-breaking CoCo in US dollars – a $1bn, 4.75% note. State-run Industrial Bank of Korea became the first bank in the country to print a CoCo bond domestically, a Won300bn, 10-year deal – in an effort to improve its financial soundness.

Even regional banks are considering printing CoCo bonds in local currency. JB Financial Group, which works in South Korea’s Jeolla region, has printed in CoCo format in September this year, while BS Financial Group, which operates in the Busan area, also announced plans to print a CoCo bond domestically.

Mr Lee says DGB will look to print a bond in this format next year. According to him, CoCos remain more attractive than covered bonds, for instance, since the latter do not provide sufficiently attractive yields to find traction even among insurance companies – covered bonds’ largest buyers.

In September 2014, Korea Exchange Bank also announced it will issue a CoCo instrument, via Singapore, with five lead managers, including Bank of America Merrill Lynch and HSBC.

Future promise

Although South Korea’s state-owned or nationwide banks have recently been in the headlines for all the wrong reasons, regional banks’ performance highlight a far more positive side of the country’s banking sector.

These firms are successfully matching bigger players’ growth paths. They are expanding abroad in China and Asean as well as diversifying their business into non-banking services. In addition, their relatively smaller domestic operational size arguably minimises the risk of poor staff management, blamed in part for the loan scandals at the larger banks this year.

DGB’s Mr Lee also points out that regional banks’ niche – each is tied to a specific geographic area – is an advantage in that they do not risk being crowded out of their own market by larger competitors or by other regional banks.

Although an observer's view of South Korea’s banking sector can often be limited to state-owned or nationwide giants, the next few years might be crucial for the development of regional firms, which though smaller in size seem sound and capable of capitalising on the same growth opportunities as other banks in the country.


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