South Korea’s financial services industry is looking to the international markets for expansion opportunities and has ambitions of creating financial institutions that can compete on a global level. While the country's conglomerates – or ‘chaebol’ as they are known locally – in the manufacturing industry have become internationally successful, the same cannot be said for the South Korean financial services industry.
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“Korean conglomerates are already known to international consumers,” says Euh Yoon-Dae, chairman of KB Financial Group, who gives the examples of LG, Samsung and Hyundai.
By comparison, the brands of the South Korean banks are weak and not known on an international scale. As the conglomerates pursued their aggressive international expansion, the banks were left behind.
And the growth potential for banks at home is drying up as net interest margins are narrowing in the increasingly saturated market. Looking overseas is an attractive prospect for the financial institutions that need to expand beyond the overcrowded domestic market, and also as part of the plan to establish a globally recognised South Korean financial institution that is on a level with the brand recognition of the country's conglomerates. The banking industry – and government – is fully focused on international expansion and lifting restrictions in order for it to happen.
The not so big bang
Reforms that were introduced in early 2009 were expected to create a ‘big bang’ in South Korea's capital markets and lead to the creation of globally competitive mega institutions. So far this has not happened, and one of the reasons cited for this is the industry was waylaid by the fallout from the collapse of Lehman Brothers in 2008.
South Korea was hit particularly hard by the crisis. Dong-Kyu Shin, chairman of the Korea Federation of Banks (KFB), highlights how the radical capital outflows, surge in the won to dollar exchange rate and volatility in the financial markets impacted the real economy. During the final quarter of 2008, South Korea experienced negative growth, at an annualised rate of -17%.
However, the country has experience in dealing with such crises, chief among them the Asian currency crisis of 1997 to 1998, which many Koreans refer to as the ‘IMF crisis’. Man-Soo Kang, chairman and CEO of KDB Financial Group, argues that such experiences helped South Korea this time around.
Mr Kang, who was the country's finance minister during the 2008 crisis, says: “We have learned lessons from the previous crisis and so Korea was able to take very pre-emptive, decisive and sufficient measures to tackle this crisis.” The measures included a fiscal stimulus package that was equivalent to 3.7% of gross domestic product, a fund to recapitalise the banks, and currency swap agreements with US, China and Japan. The Bank of Korea, the central bank, also reduced the policy rate from the pre-crisis level of 5.25% to 2% over five months.
These measures have been credited with putting South Korea on the path to recovery. The depreciation of its currency as a result of the crisis also helped the country’s export industry, which lead to an improvement in the economy.
Problems at home
Now, however, focus is turning to the issue of domestic consumption and the effect that further central bank policy rate increases could have on the domestic consumer market and the level of household debt.
Standard & Poor’s notes that the ratio of household debt to disposable income in South Korea remained high at about 145% at the end of 2010, and predicts that the credit costs will gradually rise in 2011. However, senior industry figures argue that the level of household debt is manageable, and is not comparable to the crisis in the country that was caused by the bursting of the credit card bubble in 2003.
Another area of concern is the country’s ailing savings banks, which because of poor management and inadequate supervision have suffered from high non-performing loan ratios.
Mr Euh at KB Financial Group says that while the bankruptcies in the savings bank sector will have a social impact, the effect on the wider economy will be limited.
Since the savings banks' total assets account for approximately 3.1% of South Korea’s total financial assets, the problem is not expected to pose any systemic risk, and observers argue that overall the banking sector has adequate capital and loan loss reserves to absorb the losses.
Action needed
While experts argue that South Korea has recovered from the effects of the 2008 global financial crisis, and has the ability to withstand any further shocks, the finance industry is now looking beyond its domestic situation. Pal Seung Lee, chairman and CEO of Woori Financial Group, says: “In respect of scale and competitiveness, the Korean financial industry has a long way to go. However, we believe we have [the] capacity to overcome external shocks even if we confront another global financial crisis in the future.”
While South Korea's economy, and its banking industry, has passed through the recovery phase, net interest margins continue to be squeezed. The KFB notes that net interest margins have fallen from a high of 2.81% at the end of 2005 to 2.32% at the end of 2010. While the margins have started to improve, senior industry executives argue that the potential of the domestic market is limited.
Yung Ku Ha, CEO of Citibank Korea and Citi Korea, notes that the focus of the industry has turned to how to increase the fee revenue rather than relying on net interest margins. “Going forward, banks have to expand overseas as the domestic market has become very competitive,” Mr Ha says.
Mr Shin at the KFB says: “A gradual, strategic overseas expansion is needed since a significant gap exists between Korean banks and big banks in developed countries.” He adds: “For this, Korean banks will have to enhance their competitiveness when expanding their overseas operations through choosing appropriate countries to invest in considering their comparative advantages in areas such as IT and customer networks, finding overseas niche markets in small and medium-sized project financing, and developing the advanced risk management of overseas branches.”
Government action
For this reason there has been focus in recent months on the South Korean government’s efforts to boost the international competitiveness of the country's financial institutions, to bring them up to the more sophisticated level of their international peers.
The Financial Investment Services and Capital Markets Act, which was introduced in 2009, did not have the desired effect of creating a South Korean mega bank that could be globally competitive, but there is now renewed focus on revising the regulations and establishing homegrown hedge funds.
Mr Lee at Woori Financial Group says that the reforms have the intention of creating a large investment bank in South Korea. “These efforts are expected to expand the market size and the business area for the securities industry,” he says. “The main contents of the amendments were clauses related to the development of investment banking business, including the establishment and management of hedge funds, the operation of prime brokerage services, and the approval of granting credit to corporates.”
Such measures are aimed at allowing the South Korean institutions to compete with global rivals so that they can enable the country's corporates to tender successfully for large infrastructure projects overseas, and offer them the diversified funding that they need.
Ambitious plans
How these plans will pan out remains to be seen, and observers are waiting to see how the industry will be realigned as a number of institutions in South Korea are up for sale. For example, the sale of Korea Exchange Bank (KEB) has been an ongoing issue for a number of years, having been subject to a few failed bids.
Hana Financial Group, which is looking to increase its size and expand internationally, announced in November 2010 its bid to acquire KEB, which would allow it to take advantage of KEB’s international network. However, the bank is still waiting for regulatory approval as KEB continues to be weighed down by the legal problems surrounding the initial acquisition of KEB by Lone Star in 2003. However, Hana is not resting its future plans on this acquisition, which may not go ahead if the legal issues are not resolved. For example, it is considering expanding in Indonesia, as well as looking at community banks in the US.
This international outlook is shared by the major financial institutions in South Korea. As part of its vision to create a homegrown global corporate and investment bank, the government announced in June 2008 that it would privatise Korea Development Bank, and in June 2009 KDB Financial Group was launched as part of this restructuring.
KDB Financial Group has its international strategy mapped out. In the first stage it aims to become one of the top 20 banks in Asia, and the second stage to become one of the world's top 20 corporate and investment banks by the year 2020. KDB says that its initial focus will be on Asia as well as promoting its services in traditionally strong areas such as infrastructure project finance and corporate restructuring.
“We have to make strong and sustainable efforts to develop our financial industry,” says Mr Kang. He adds: “At KDB we are looking for opportunities for mergers and acquisitions in the domestic and overseas market.”
Good timing
Jinho Kim, senior managing director and chief financial officer of KDB Financial Group, notes that the group is well placed to expand overseas as it is not necessary for it to establish a branch network in order to compete in the infrastructure finance market. He notes that the opportunities lie in fast-growing Asian economies where the governments do not have sufficient financing to develop their infrastructure, and thus their economy.
“In the past, European banks were very active in providing financing to Asian countries. Those European banks have problems in their own markets,” says Mr Kim. “The next three years is the best time for KDB to expand and set up a presence in Asian markets. We are looking at the Middle East and Africa as well.”
This outward-looking stance is shared by Woori Financial Group, which was established as South Korea’s first financial holding company 10 years ago. The government currently holds 57% stake in the group and is in the process of privatisation.
Woori chairman Mr Lee is also looking at opportunities overseas. “To overcome the growth limitations of the mature domestic market, and to advance to become a global financial group, international expansion is essential,” he says.
“Currently, Woori Financial Group needs to expand its non-banking business because it focuses on the bank-oriented business portfolio and the non-banking business only accounts for 15%. We are committed to building the insurance and the non-banking business next year when the revised capital market act will take effect,” he adds.
Woori currently has 38 branches in its overseas network and plans to expand this through its subsidiaries or with mergers and acquisitions (M&As) in other markets. For the countries and markets where Woori does not have a presence, it plans to acquire or form alliances with local banks, especially in China and Asia. “If we are fully privatised, we will have more autonomy; the M&A attempts will be easier than they are now. We have the opportunity to take this business to the next level,” says Mr Lee. Woori plans to intensify its presence in China and Indonesia and is looking at other opportunities in the US, China, south-east Asia and Latin America. It is also undertaking discussions to establish a presence in Chennai, São Paulo and Sydney.
For the right reasons
Mr Euh at KB Financial Group argues that any expansion and growth should focus on improving costs and efficient management, and educating and improving the quality of management. He notes that there is a lot of discussion about looking abroad and internationalisation. “I do not think there is competitive advantage in doing that because the stock price of Korean financial institutions is so low that with the prices of M&A, and with the dilution of stockholders value, foreign investors will not allow us to do that kind of mathematics,” he says.
He adds that the efforts of KB have been on improving efficiencies, increasing the number of hours spent on training and strengthening the quality of management.
Such strategies are no easy feat, and the rest of South Korea's financial institutions also have their work cut out in achieving their global visions. With the domestic market becoming increasingly competitive, Korean institutions also face a competitive international market as they aim to compete with global financial institutions, as they aim to build Korean financial services brands that are on a par with the Korean conglomerates of the manufacturing industry.
