Korean Banks Are Facing Growth Crisis

Clients turn away from banks for higher returns-

At the beginning of 2000, Korean banks started to make themselves bigger in size.

At a time when insolvent financial companies were shutting down through restructuring right after the East Asian financial crisis, and a number of banks were reviving with the help of public funds injected by the government, clients began to show preferences for stable assets. The large surviving banks have been expanding their assets through loans to enterprises when the IT business was booming in 2000, through attracting credit card users when competition for card customers was high in 2002, and through housing-mortgage loans in 2005 and 2006.

But as the interest rate continued to stay low and the stock market shifted upward, clients now began showing changing attitudes toward banks. They are showing higher preference for “high-risk, high-return” assets, such as the funds offered by bond companies, as opposed to safer bank savings returns.

The amount of demand deposits in the four major banks, Kookmin, Shinhan, Hana, and Woori, contracted by 3.725 trillion won in two months from 109.234 trillion won in March this year to 105.511 trillion won in May. And the balance of long-term financial instruments in banks with a maturity of more than two years as of end May only grew by 1.9 trillion won compared to the end of last year. Given that the balance of short-term financial instruments with maturities below six month have grown by 52.6 trillion won from the end of last year, the record is far too poor.

With housing mortgage loans tightened, the banks turned competitively toward loans to small and medium enterprises this year, but this means higher risks in return for themselves, considering the low assessment ratings on enterprises by domestic banks.

In search of a new growth engine-

The financial supervisory authority points out that, “The problem is the lack of a new source of income in banks, while the financial environment has changed greatly.”

Though the net profit of domestic banks in the first quarter of this year increased by 2.696 trillion won year-on-year, it was solely the result of temporary factors such as the income from the sale of LG Card stocks. Their operating profits have stagnated. Net interest margin, a typical index for the profitability of banks (profit minus the funding cost divided by aggregate assets), dropped from 2.80 percent in the first quarter last year to 2.46 percent in the same period this year.

“The times are over when it was possible for banks to enlarge their assets in a short time,” wrote Daehan Investment Management Company in a report titled, “The Times of the Investment Banking Business.”

It was because the development of income sources in the non-interest sector, such as derivatives, has been dull, while the income from the interest sector, which takes up 90 percent of profits of domestic banks, is continually decreasing due to calls from enterprises for lower interest. This report suggests five strategies for further growth of domestic banks: consolidation, multi-functionalization, and the expansion of foreign markets through investment banking. But many see obstacles to this in reality.

Lee Geon-beom, a researcher at the Korea Institute of Finance, says, “In order for the banks to find a breakthrough, they have to diversify their business sectors, including their asset backed securities and funds while simultaneously maintaining the conventional baking sector.”