Korea’s regional banks power ahead

Low economic growth, an extremely competitive banking market and record low interest rates are keeping South Korean lenders busy. And smaller, regional banks that service small and medium-sized enterprises (SMEs) and retail clients in their own catchment areas are generally suffering more than the larger, Seoul-based banks.

But Busan-based BNK Financial Group and Daegu-based DGB Financial Group are two examples of regional banks that are doing particularly well. The banks’ strong involvement in the real economy, a broadening of scope through mergers and acquisitions (M&A), and expansion abroad are helping them navigate a tricky domestic environment. If regulatory discrepancies obstructing growth in non-interest income are resolved, these banks could grow further, according to some analysts.

Regional restrictions

Regional banks in South Korea can only cater to clients within the borders of the regions they cover. This means their success is somewhat predetermined by their catchment area. BNK and DGB are lucky in that the regions in which they operate are both prosperous. 

Regional banks are key to their area’s economic growth as they support local SMEs, which remain underserved by South Korea’s banking sector. By law, SMEs need to account for at least 60% of regional banks’ portfolios. “SMEs still have a hard time finding funding since interest rates are kept high,” says Se-Hwan Sung, chairman and chief executive at BNK Financial Group.

Regional banks are best placed to serve SMEs, whose risk is harder to assess when compared with larger firms. “We meet SMEs personally and have very good information on these companies. We can serve them better than anyone else,” says Matt Lee, head of investor relations at DGB.

And even though SME lending is relatively risky, returns can be far more attractive. “There is higher risk but our business with them is based on collateral. If it is risk-managed, this business is more profitable than servicing large corporates,” says Mr Sung.

DGB’s loan portfolio – 70% of which focuses on SMEs – is growing by 8% to 10% a year thanks to new medical sector projects and national industrial complexes in the region. “Ten percent growth is our limit otherwise our capital adequacy ratio would be under pressure,” says Mr Lee.

Growing at home

Although the SME business is going well, South Korea’s tough macroeconomic conditions and record low interest rates of 1.5% do not make for an easy environment in which to operate. Banks are being pushed to find new ways to stay profitable. 

“The lending yield and the funding yield are both dropping. The fee income therefore needs to increase and we need to continue improving our non-interest income,” says Mr Sung. 

But Mr Lee argues that regulatory discrepancies are making it hard for South Korean banks to increase non-interest income. “[For instance], if you open an account and send money to foreign countries, you pay no commission as a client,” he says. In 2008 and 2010, South Korean regulators made all banks cut fees and commission. 

Now, the regulators’ administration has changed and banks are encouraged to increase non-interest income. But regulatory inconsistencies are obstructing this process. “The Financial [Services] Commission [FSC] wants banks to increase non-interest income and dividends. But Korea’s Financial Supervisory Service – [which is overseen by the FSC] – is resistant to changing regulation,” says Mr Lee.

Acquisition strategy

In addition to increasing non-interest income, regional banks are targeting domestic acquisitions to increase revenue. “We are always trying to diversify our [financial group’s] portfolio at a reasonable rate,” says Mr Sung.

To branch out of the niche and highly competitive Busan region, in May 2015 BNK acquired Kyongnam Bank, which focuses on the neighbouring Kyongnam and Ulsan areas. “By acquiring Kyongnam Bank we now cover the second largest economic area in Korea. It created good economies of scale,” says Mr Sung.

Kyongnam Bank was formerly part of state-owned Woori Bank, which is itself up for sale. The South Korean government is looking to sell its 51% controlling stake of Woori Bank to recuperate more than $12bn, which it spent to bail out the bank and its affiliates a decade ago.

The government’s willingness to exit banks it once helped fund benefited BNK’s transaction. “The government wanted to get the money it spent to fund [Kyongnam Bank] back,” says Mr Sung.

BNK maintained a two-bank status post-acquisition as there is no overlap in customers with Kyongnam Bank. However, parallels in the industries served by the two banks (car, shipbuilding and machinery sectors) will make it easy for BNK to source new business and to then explore new industries, such as the aerospace and nano sectors in Kyongnam province, says Mr Sung.

BNK’s balance sheet also benefited from the acquisition. Its overall assets jumped from Won33,000bn ($26.4bn) in 2009 to Won101,000bn as of the end of June 2015. And BNK’s acquisition strategy may yet continue. “We have been looking into potential M&As for a very long time now,” adds Mr Sung.

Expanding financial groups

Regional banks are also expanding their financial groups’ scope to diversify revenue sources further. As regional banks are limited by their catchment area, adding subsidiaries to their portfolio is a way to grow.

To this end, DGB acquired Woori Aviva Life Insurance, now called DGB Life, in early 2015. “To keep our customers, we needed to start offering insurance as part of the different services included in our financial group,” says Mr Lee. 

The Woori Aviva acquisition also benefited DGB’s balance sheet. The group’s assets increased from Won46,000bn in the fourth quarter of 2014 to Won54,880bn the next quarter.

DGB Life adds to DGB’s bank, capital, data system, credit information and electronic payments subsidiaries. And by the end of 2015 or early 2016, DGB will either acquire or organically set up an asset management arm to cater to customer needs, according to Mr Lee.

BNK also realised the need to move beyond banking alone. “Around 2011, we decided we had to change our growth strategy and start building a financial holding company with diversified subsidiaries and product offerings,” says Mr Sung.

BNK today has banking, securities, capital, credit information, IT, money services and asset management subsidiaries. In July 2015, it acquired 51.01% of the asset management arm of South Korean insurer GS Group.

“We are looking to include other financial institutions, such as an insurance company, to diversify our group further. We are living in a low-rates environment and diversifying earnings away from banking per se is key,” says Mr Sung.

To go or not to go abroad?

For some regional banks, diversification also comes in the form of expanding abroad. BNK aims to have 30% of total profits come from overseas investments by 2030. “Expanding overseas is crucial for our future,” says Mr Sung.

Notably, BNK recently set up microfinance operations in Myanmar – a market that is hard to crack even for global banks as it has not had a functioning financial market for more than two decades. Launched less than 12 months ago, BNK’s business already has more than 10,000 clients and the Myanmar government is keen for it to expand into the southern Mon region. 

BNK’s Myanmar work will continue to focus on microfinance. “We are not trying to get a banking licence in Myanmar at the moment. There is far less regulation for non-bank entities,” says Mr Sung.

The bank has capital subsidiaries in Cambodia and Laos, as well as a branch in Qingdao, China, and an office in Ho Chi Minh City, Vietnam, which could become a branch by the end of 2015. BNK’s next objectives are to set up an office in Mumbai, India, and to either acquire a bank or set up a branch in Indonesia to service local clients.

While BNK is pushing for overseas expansion, DGB does not have an aggressive international strategy. “As a regional bank focused on our community, we don’t need to build a large branch network abroad,” says Mr Lee. DGB supports Daegu-Gyeongbuk SMEs overseas with a Shanghai branch and a liaison office in Hanoi, Vietnam, which could be upgraded to a branch. 

While regional banks are smaller in scope compared with their Seoul-based peers, their efforts to diversify revenue sources in a low-growth, low-interest-rate environment are significant. If regulatory discrepancies disappeared, these efforts could bear even richer fruits. And with the real economy at the crux of regional banks’ operations, these smaller lenders are arguably even more sustainable than some of South Korea’s larger banks.