Why Korean banks will remain steady despite subdued Q3 profits

They stand to benefit from expansions and from the low-rate policy environment.

Despite their subdued profitability in Q3 and oncoming macroeconomic challenges, South Korean banks are expected to report a steady performance for the remainder of the year on the bank of their expansionary monetary and fiscal policies and sound risk appetite, according to Fitch Ratings.

On a yearly basis, local banks are reportedly showing modest decline in profitability due to narrower interest margins and slightly higher credit cost. However, these are still in line with expectations, said Fitch.

Korea’s four major banks—Kookmin Bank, Shinhan Bank, KEB Hana Bank, and Woori Bank—reported “resilient” financial performance for the first three quarters of 2019. However, they did show a modest decline in risk-adjusted profitability, which can be observed from the average operating profit/risk-weighted assets dipped to 1.8% in 9M19, from 2% in 9M18, due mainly to a 5bp contraction in net interest margins and another 5bp increase in credit costs.

But this contraction of net interest margins are expected to slow in the coming quarters, as the impact of lower lending rates are projected to have already taken place in Q3. The low policy-rate environment also allows banks to benefit from cheap funding costs, and thus gain access to ample liquidity, according to Fitch Ratings.

The slowing economic growth (down to 2% for 2019 from 2.7% in the previous year) is also unlikely to hit on the banks’ performance whilst no signs of deterioration of asset quality was observed at this stage. The banks’ expansionary monetary and fiscal policies, and their sound risk appetite, is expected to mitigate the impact. Local banks have reportedly been pursuing both organic and inorganic expansion overseas, especially in Southeast Asian countries, to boost profitability.

In addition, Kookmin, KEB Hana and regional banks reduced the number of long-serving staff in 2019 through an early retirement plan to support operating efficiencies. This increased the average cost/income ratio for the four major banks to 49% on a yearly basis in the first nine months of 2019 from 47% YoY in 9M18, but the ratio would have remained broadly similar without the retirement plans and other one-off expenses.

The banks' improved underwriting standards, evident in the significantly lower loan concentration to single obligors and higher secured loan mix over the past five years, should also reduce the chance of banks reporting large credit losses if the economic downturn intensified, noted Fitch Ratings.

But major banks would face competition over deposits in light of the tighter loans-to-deposits regulation aimed at curbing expansion in household debt, effective from 2020, and the launch of open banking services in October 2019.

Despite these, South Korea’s four major banks’ overall dividends are anticipated to increase on the back of heightened acquisition activities by parent bank holding companies in recent years for non-bank financial institutions.

Photo courtesy of Kaniwari (Wikimedia Commons).