Korean banks struggle to diversify business portfolios

Local lenders lag behind global players due to heavy-handed regulations

By Lee Yeon-woo

Accessing financial services was relatively simple in the past, since there were few options other than to physically visit a bank branch to do that. With the advent of digitalization, however, competitors from the IT industry have entered the financial sector, equipped with innovative services that are much more convenient to use.

This global phenomenon, often referred to as the big blur, resulted in the diminishing competitiveness of traditional banks, thereby forcing the financial industry to diversify its business portfolio in order to survive.

Last July, JPMorgan Chase & Co. announced plans to enter the tourism industry by acquiring restaurant website, Infatuation, and a travel mileage platform called cxLoyalty. Various global banks, such as Bank of America, Deutsche Bank and DBS Bank in Singapore, have since followed suit.

Even banks in Japan, which has been suffering from a protracted economic recession, are striving to increase their profits outside of interest earnings, encouraged by the government's easing of regulations. Last July, MUFG Bank, affiliated with the Mitsubishi UFJ Financial Group, began a trading business whereby it purchases company's inventory at a low price and then resells it at a markup.

Korean banks, however, are lagging behind in such efforts due to long-standing regulations.

The existing regulations, which restrict the banking industry from entering other business sectors, aim to prevent the financial instability of non-financial sectors from spilling over into the banking industry. It also intends to curb the excessive influence of financial institutions over other industries.

“Over the past decade, traditional banks (in Korea) have faced significant structural changes, due to a stagnant economy, heightened competition, and the rise of digital finance,” said Lee Byung-yoon, a senior research fellow at the Korea Institute of Finance. “If the current operating environment persists, it could not only deteriorate the key performance metrics of these banks, but also potentially threaten their very existence.”

The profit model for banks within Korea is more reliant on income from interest rates compared to international banks. The Financial Service Commission (FSC) noted that the average share of interest income stood at 88 percent in Korea over the last five years. It also warned that the current model exposes banks to substantial risks from market interest rate fluctuations, potentially undermining their financial stability.

“The banking sector is aware that many people hold critical views regarding its huge profits, and is therefore making efforts to diversify its revenue structure, which is currently heavily dependent on interest rates,” Park Chang-ok, an executive director at the Korea Federations of Banks, told reporters last week. “Regulations need to be eased urgently for that purpose.”

Financial analysts argue that existing regulations should be revised to reflect evolving economic conditions. Additionally, when banks venture into new types of businesses, they can introduce more competition in the platform industry, thereby increasing the number of choices available to consumers.

“It's crucial to closely scrutinize whether a level playing field is being established to ensure fair competition between traditional banking institutions and these tech companies, especially in the context of regulatory arbitrage,” the Bank of Korea noted in its research on the issue.

Several pilot projects offering new services from commercial banks have been partially approved by financial authorities to encourage innovation. But few of these services have made a lasting impact on the market, apart from Shinhan Bank's food delivery brokerage service and KB Kookmin Bank's mobile virtual network operator service.

But such changes are expected to face considerable challenges ahead.

In August, the FSC abruptly put the brakes on ongoing discussions, partially due to a backlash from small and mid-sized enterprises (SMEs).

“During the consultation process, it was suggested that there needs to be adequate prior communication and input from SMEs, small business owners, and other operators in non-financial sectors. The timeline for the announcement has been postponed as a result,” an FSC official explained.

The FSC intends to initiate the integration of financial and non-financial sectors in areas where there is no risk of unfair competition between larger financial firms and SMEs.

“In light of recent illegal activities by employees in the banking sector, there is a growing consensus that financial firms should first enhance their risk management and internal control systems before considering expansions into non-financial fields,” said a market insider, asking not to be named. “Given these circumstances, it becomes crucial for these firms to proactively develop strategies for handling such incidents while preventing them from happening again.”