Banking on the future

• Published Aug 26, 2015 4:57 PM KST
• Updated Aug 26, 2015 4:57 PM KST

By John Burton

The scheduled merger of Hana Bank and Korea Exchange Bank on September 1 is an effort to bolster the nation’s banking sector ahead of what could prove to a rough period in the global economy. Memories of how the 1997 Asian financial crisis devastated the Korean banking system are still strong.

The new KEB Hana Bank, which will be nation’s largest bank by assets, can trace its roots to that crisis when KEB was taken over by Lone Star before the U.S. equity fund sold its majority stake to Hana in 2012.

The merger comes at a time when Korea is facing economic headwinds. Korea’s exports of autos and other important products have fallen this year due to the negative impact caused by the weakening currency of its main trade rival Japan. Domestic demand is also slowing.

In response, the Bank of Korea has cut the base interest rate to record low of 1.5 percent to help support the economy and rates could fall further. That is putting pressure on the profit margins of the local banks, which have already been suffering from low growth and thin interest margins since the 2008 global financial crisis.

The government has been encouraging a consolidation of the banking sector to strengthen the fragmented industry and ensure its continued development. But little progress has been made until now, mainly because of opposition from militant bank trade unions that fear job losses. The KEB union, for example, derailed previous merger proposals with Hana and they only agreed to the deal after clauses were included in the agreement guaranteeing job security and current wages for KEB workers.

Analysts believe that the Hana-KEB merger could serve as a model for further consolidation in the banking sector since the two banks have complementary businesses. KEB is strong in foreign exchange, overseas finance and corporate finance, while Hana’s strengths are in retail finance and private banking.

Hana also view KEB as a secure platform to increase its presence overseas by creating the biggest foreign network among Korean banks. The economies of scale achieved through the merger will also provide financial resources to help support Hana’s overseas expansion.

With the world appearing stuck in a low-interest environment, narrowing interest rate margins _ the difference between loan and deposit rates _ is likely to put pressure on other Korean banks to merge. The average net interest margin for local banks is now at a record low of 1.72 percent.

Emerging debt problems in some of Korea’s key export industries could also accelerate a bank merger wave. The shipbuilding, oil refining, chemicals and steel industries are suffering from growing debt piles as global sales weaken due to excess capacity, lower oil prices and sluggish demand.

A stagnant domestic economy is also increasing the number of “zombie” firms, those unable to make full debt repayments, to more than 15 percent of all local companies. Cheap state loans and subsidies are keeping them from collapsing and plunging the country into a new financial crisis.

Although the overall non-performing loan ratio, which measures bad loans, is a relatively low 1.56 percent, the ratios for the shipbuilding and construction sectors have surged to above 5 percent. Moody’s, the credit ratings agency, estimates that 12 percent of corporate lending by banks is in cyclically weak sectors such as shipping, shipbuilding, construction and steel.

Zombie companies could multiple as Korean manufacturers face increased competition from China and Japan, whose exports have been boosted by currency devaluations as seen in the smartphone, consumer electronics and auto sectors.

Moody’s recently warned that the profitability of Korean banks is weakening while their cost efficiencies are deteriorating, the same problems that have been affecting Japanese banks. However, while both Korean and Japanese banks have better asset quality when compared to global competitors, Japanese banks have more diverse revenue sources and lower credit risk on their balance sheets than Korean banks.

Moreover, the profits of Japanese banks are improving while the profitability of Korean banks is falling. One reason for the improved performance of Japanese banks is overseas growth.

Korean banks face other potential problems. Most of bank lending is to small and medium businesses, the most vulnerable sector of the economy, and households, which have among the highest household/income debt ratios in the world at 160 percent.

No one is predicting yet that Korean banks are in danger of repeating the traumatic experience of the 1997 financial crisis. But it is the quest for higher profits by expanding abroad while improving cost efficiency at home that lies behind the Hana KEB merger. Other Korean banks may soon have to follow suit.

John Burton, a former Korea correspondent for the Financial Times, is now a Seoul-based independent journalist and media consultant. He can be reached at john.burton@insightcomms.com.