Banks All-Out to Develop New Earnings Sources
By Na Jeong-ju
Banks have recorded sharp earnings growth for the past couple of years on strong demand for mortgages and corporate loans. However, they are finding it increasingly difficult to boost their bottom line amid growing fund-raising costs and stiffer competition with non-banking financial institutions, analysts say.
Starting next year, banks will have to increase provisions for possible loan losses to cope with potential risks arising from a hike in corporate lending.
``As banks' lending to corporations, mostly smaller firms, has soared since 2006, it would be proper to impose stricter rules on reserves to be prepared for future losses while lenders are still financially healthy,'' said Kim Dae-pyung, FSS deputy governor, at a media briefing. ``Banks are also faced with falling loans to households and deteriorating profitability.''
According to the Financial Supervisory Service (FSS), the minimum provisioning ratio for corporate loans classified as ``normal'' will rise by 0.15 percentage points to 0.85 percent.
The corresponding ratio for loans to building, real estate and rental, retail and wholesale as well as restaurant and lodging sectors will go up by 0.5 percentage points to 1.2 percent. The ratio for loans classified as ``precautionary'' or ``substandard'' will remain unchanged at 7 percent and 20 percent, respectively, the FSS said.
In compliance with new rules, the nation's 18 commercial lenders will have to set aside approximately 1.4 trillion won ($1.84 billion) more to cover loan losses when they close their books for 2007.
Banks have seen the balance of their deposit accounts fall sharply in recent months amid low interest rates for banks' deposits, while being engaged in a heated competition to attract more borrowers. The deposit balance has fallen below outstanding loans at Kookmin, Woori and some other large-sized lenders, putting them in a more difficult position in improving profitability.
If the situation gets worse, banks may move to hike the interest rates for loans to prop up their interest income, raising borrowers' interest payment burden further.
``Most banks are suffering an erosion of deposits, which are essential for them to maintain profitability,'' said Kim Woo-jin, an economist at the Seoul-based Korea Institute of Finance. ``The erosion of core deposits may weaken banks' growth potential amid growing competition with non-banking financial institutions.''
The average net interest margin (NIM) of Korean banks, a key gauge of profitability, has fallen this year amid stiffer competition, denting their profitability. Banks have competed to raise interest rates on deposit products and cut lending rates to attract more customers, resulting in a fall in the gap between lending and deposit rates.
Analysts said the intensifying competition in the banking sector may prompt commercial lenders to lower their expectations for profits next year.
``Stronger competition among banks will be reflected in their business results this year. It is time for them to focus on bolstering risk management,'' said Lee Byung-Yoon, a KIF researcher.
Bank executives are gripped by a stronger sense of crisis.
Recently, Shinhan Bank CEO Shin Sang-hoon expressed concerns about banks' falling interest margins.
``Banks may face higher credit risks if economic uncertainties grow due to high oil prices and the won's appreciation against the dollar,'' Shin said. ``This is the time to strengthen our risk management capabilities and to improve the quality of our assets.''
Hana Bank President Kim Jong-ryul also called on employees to put emphasis on strengthening its credit card and other non-banking businesses in the second half, saying the bank needs to overhaul its business line-up to improve productivity.
Major banks' performance worsened in the third quarter with their net interest margin (NIM) falling on losses stemming from their exposure to U.S. subprime mortgages and rising costs of fund raising. The NIM is the gap between the lending and deposit rates after the reflection of all costs.
Lenders used to attract funds through low-interest core deposits and extended loans to households and businesses at higher rates, generating easy profits. But the average NIM of Korean banks has dropped sharply as they have competed to raise interest rates on deposit products.
Shinhan Bank posted 316 billion won in net profits in the July-September period, down 55.5 percent from the previous quarter, while Woori Bank saw its net profit decline 54 percent to 244 billion won because of losses on its investment in securities backed by U.S. high-risk housing loans.
Also, third-quarter net profits of the Industrial Bank of Korea (IBK) and the Korea Exchange Bank fell 32 percent to 218 billion won and 30 percent to 194 billion won from the second quarter, respectively.
The country's largest retail lender Kookmin Bank saw its profits decrease 2.8 percent to 2.26 trillion won in the first nine months of the year as its NIM fell on rising deposit rates and falling lending rates.
The lender's NIM stood at 3.27 percent in the third quarter, down from 3.54 percent in the second quarter and 3.6 percent in the first quarter. Woori Bank's NIM fell to 2.37 percent from 2.49 percent in the January-March period, while Shinhan Bank saw its NIM decrease to 2.25 percent from 2.28 percent over the same period.
Banks' non-performing loans (NPLs) have also increased, further deteriorating their bottom lines. The IBK saw its NPLs reach 0.91 percent of its entire loans as of the end of September, up from 0.58 percent three months earlier. Hana Bank's NPLs rose to 0.8 percent from 0.75 percent.
Gu Bon-sung, a KIF researcher, said local lenders were widely expected to record lower profits next year.
``Banks will continue to struggle in the coming months as mortgages and other loan markets have reached saturation point. Also, the shift of funds from the banking sector to securities companies will likely accelerate as the Capital Market Integration Act takes effect in 2009, further weakening banks' bottom line.''
He said lenders should advance into non-banking businesses and explore opportunities overseas to find new sources of income and nurture future growth engines.
``Rather than relying on easy NIM profits, banks should strive to develop new financial products to attract customers and compete with brokerage firms in the emerging wealth management market,'' Gu noted.