Korean Card Industry Evolving
By Kim Jae-kyoung
This is the first of a six-part series of articles on the local card industry and credit card companies.
The U.S. financial crisis triggered by the subprime mortgage meltdown has shaken the banking sector across the globe and is now set to hit the credit card sector. U.S. credit card firms are facing a surge in card losses due to the prolonged economic recession.
According to U.S. federal regulators’ bank stress test results, in a worst case economic situation, 19 of the U.S. biggest banks can expect nearly $82.4 billion in credit card losses by the end of 2010.
The results also show that around 20 percent of the credit card balances at American Express and Capital One Financial are expected to go bad over this year and the next, with 23 percent of card loans expected to sour at Bank of America, Citigroup and JP Morgan.
Lessons from Credit Card Fiasco
Although Korean credit card firms, of course, are not immune to the global economic crisis, they have been tiding over the ongoing turmoil much better than their counterparts in the U.S.
Ironically, the global crisis has set local plastic issuers apart from foreign card firms as they have successfully managed credit risks with rich experience and know-how they gained when they underwent the credit card disaster in 2003.
In early 2000, credit cards became readily available in Korea for the first time and there was tremendous competition to get credit cards in the hands of consumers by the issuers.
If a person was breathing, they qualified for a credit card irrespective of their job status, their credit status, their income levels. Like the mortgage lenders in the U.S., the Korean credit card issuers forgot traditional credit policies that should be applied in issuing credit cards and the country ended up with more than three million persons with defaulted credit cards.
Back then, local card firms issued plastics on the street even to the jobless and college students with no income, and many of them ``robbed Peter to pay Paul,’’ which left many of them saddled with snowballing debts. The government, on its side, inflated the credit card bubble by encouraging card use to stimulate private spending and secure more taxes.
As a result, the default rate of six credit card firms averaged 28.28 percent at the end of 2003. In order to expand their businesses, they focused on cash advance services and card loan businesses rather than on credit sales.
With a surge in bad assets and a liquidity shortage, Kookmin Card, Woori Card and Korea Exchange Bank (KEB) Card were merged into their parent banks, while other issuers barely avoided bankruptcies thanks to creditors’ debt-for-equity swaps. The fiasco generated lots of credit defaulters, shaking Asia’s fourth largest economy.
However, the incident was good medicine for local card firms. They took huge lessons from the painful experience and have since made their best efforts to become more sound and stronger by employing strict credit risk management strategies.
In line with the improvement in card issuers’ business practice, consumers also changed their spending behavior. In 2002, credit sales accounted for 38.1 percent of card firms’ business, compared with 61.9 percent for loan services. The ratio of credit sales increased to 66.9 percent at the end of 2005.
The default rate fell to 18.24 percent in 2004, 10.5 percent in 2005, 5.53 percent in 2006 and 3.79 percent in 2007. The rate further decreased to 3.43 percent at the end of last year even when the country was at the center of the global financial crisis.
In the first quarter of this year, five card firms ― Shinhan, BC, Samsung, Lotte and Hyundai ― posted a combined net profit of 419.2 billion won, down 34.1 percent from the same period last year. But excluding BC’s one-time special profit of 354.2 billion won last year, the income was up 48.9 percent.
Their operating income increased by 2.3 percent to 3.26 trillion won during the same period, while their default rates edged up 0.16 percentage points to 3.59 percent.
``Card firms’ profitability and financial health remain very sound despite the deepening economic slump. I think card issuers’ efforts to strengthen risk management after the 2003 card fiasco are now paying off,’’ said an official of the Financial Supervisory Service.
Some market experts said that the U.S. needs to take a lesson from Korea to clean up the financial mess, noting that the mortgage problem in the U.S. is similar to the credit card industry boom in Korea in early 2000.
``It is not unlike the credit card problem we had in Korea and the U.S. could learn some things from the way in which Korea handled that problem,’’ Jeffrey Jones, an international lawyer and former AMCHAM chairman, told The Korea Times.
``The U.S. needs to establish policies to help people stay in their homes and continue to pay their mortgages, helping the default rate stop,’’ he added, suggesting that the U.S. take a lesson from some of the programs Korea used, such as the personal debt workout program.
World’s Second Largest Market
Korea’s credit card market has grown rapidly over the past few years and is now the world’s second largest market. The card market expanded at an explosive pace over the past three years on the back of the government’s tax benefits and card issuers’ aggressive marketing. The growth slowed to a moderate pace since the second half of last year but the market is still growing at a robust pace.
Against this backdrop, Visa and Master Card, two major global card firms, have been in a cutthroat competition in the local market. In particular, in connection with Korea’s developed IT industry infrastructure, the two are trying to use Korea as a pilot market to test newly developed, next-generation credit card technologies.
In 2001, on a year-on-year basis, the market grew 122.5 percent in the first quarter, 113.3 percent in the second quarter, 106.5 percent in the third quarter and 97.1 percent in the fourth quarter. Last year, the market grew more than 70 percent.
Private Consumption Expenditure, the ratio of credit card sales to gross domestic product (GDP), shows how well-developed the Korea’s card market is. The PCE number for Korea is 57.4 percent in 2008, compared with 23.1 percent for Australia and 16.2 percent for Hong Kong. The average figure for Asia-Pacific region stands at 8.1 percent.
According to the Bank of Korea (BOK), the card (including all kinds of cards ― credit, debit, check and prepaid) penetration in South Korea is quite high, with the world’s second-highest per capita card issuance. Each South Korean holds on an average of 3.78 cards as of August last year, trailing only the U.S. with 5.3 cards. A total of 183 million cards were issued in Korea ― 92 million credit cards and 90 million debit and check cards.
Trailing behind were Singapore with per capita card issuance of 2.98 cards, followed by the U.K. (2.36), Netherlands (1.92), Belgium (1.57), Switzerland (1.37), Germany (1.31) and Italy (1.14).
``Credit card use is much more popular in Korea, while debit cards are used more in countries such as Japan, Germany and the Netherlands,’’ a BOK official said.
The central bank also said that Korea has a low level of cash possession in the private sector. The private cash-M1 ratio was 5.8 percent, the second lowest among the 14 major economies and trailing Britain’s 4.5 percent. Average cash possession per capita remained flat at $482, less than one-fifth of that of the United States at $2,736.
With the rising popularity of electronic banking and stupendous growth in IT industry, the number of payment cards ― debit, check and prepaid cards ― has surged in South Korea.
According to a research report titled ``South Korean Payment Card Market’’ by RNCOS, a global research firm, despite a deep economic slump, the uses of bank cards will grow at rapid pace owing to the enhancement of various benefits and expansion of scope available for settlements.
Among all cards, the uses of check cards are expected to record the sharpest increase at an annual growth rate of over 36 percent during 2009-2013. Check cards refer to cards containing functions of both credit and debit cards.
On the other hand, debit cards are expected to show a downtrend during the period. With no risk involved, prepaid cards are also anticipated to show significant growth in future.
``The sharp rise (of the uses of check cards) will chiefly be attributed to the fact that the use of check cards is possible 24 hours a day at merchants, much longer than debit cards,’’ the research firm said in a recent press release.
``Secondly, deposit holders even aged over 14 are entitled to use check cards, regardless of their credit status, and check card holders can get additional services according to use such as the accumulation of points,’’ it added.
It pointed out that the ongoing gloomy economic environment will not have any negative impact on the check cards.
``In fact, the environment will stimulate growth in such cards as they have comparatively less delinquency risk involved to issuers. However, the growth rate of other cards like credit cards may be adversely affected by recession. Issuers are hesitating in issuing new credit cards due to the fear of bad debt,’’ it said.
In its outlook report on the Korean card market, Hana Institute of Finance said that despite sluggish consumer sentiment caused by the deepening economic downturn, the use of credit cards is expected to grow 6.3 percent to 510 trillion won in 2009 on the back of rising demand for cash advance services and loans.
``In 2009, card issuers are expected to avoid expansion and put a priority on financial health by strengthening risk management,’’ the institute said.
``Their profitability is likely to get worse this year due to falling commissions for affiliated stores coupled with rising marketing costs, which we believe will be offset by rising interest income thanks to a rise in cash advances,’’ it added. ``The lesson from the 2003 card fiasco will probably have them maintain emergency mode by strengthening market monitoring.’’