Korean Banking Industry:
Current Situation & Future Strategies
February 3, 2010
Jae-Ha Park
Vice President
Korea Institute of Finance
Korea Institute of Finance
0
Contents
I.
Korean Banking Industry: Current Situation and Tasks Ahead
II.
2010 Industry Outlook
III.
Future Strategies
1.
Strengthening Loan Management and Profit Generation Capacity
2.
Preparing for Stricter FSB Prudential Regulations
3.
Preparing Industry for Structural Change
4.
Overseas Strategies
Korea Institute of Finance
1
Contents
I.
Korean Banking Industry : Current Situation and Tasks Ahead
II.
2010 Industry Outlook
III.
Future Strategies
Korea Institute of Finance
2
Eroding Profitability of Korean Banks

Net income has slid since 2007

ROA has worsened since 2005
-Return on Assets (ROA)
and Loan Loss Provisions-
-Net Income(trill.won)
20.0
(%)
16.0
14.3
13.6
15.0
1.27
1.2
13.3
1.11
1.10
1.0
8.8
55.4
8.9
8.0
0.6
12.9
0.0
0.8
12.0
10.2
9.6
0.85
7.6
4.9
1.7
(trill.won)
1.4
421.7
10.0
(%)
5.1
-2.3
-40.2
4.8
0.4
0.47
4.5
4.0
-49.2
-66.4
0.2
-10.0
0.17
0.0
03'
04'
05'
06'
Net Income(L)
Note: 1) Domestic Bank
2) Net income is cumulative
Source: FSS
07'
08'
Growth Rate(R)
09.Q3
0.0
2003
2004
2005
Provisions(R)
2006
2007
2008
09.Q3
ROA(L)
Note: Domestic Banks
Source: FSS
3
Weakening Ability to Generate Profits

NIM has been decreasing since 2005
•

In particular, NIM continued to decrease between 2005 and 2007 when interest rates was
rising as competition among banks was excessive.
Core profit ratios, an indicator of banks’ ability to generate profits, has been
consistently decreasing since 2004
•
The ratios such as “interest income/total assets” and “fee income/total assets” have suffered
since 2004 from weakening interest and fee income bases
- Breakdown of Return on Asset (ROA) and Net Interest Margin (NIM)1)(Unit: %)
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Q3 20092)
Core Profit Ratio3)
1.95
2.14
2.07
2.33
2.48
2.71
2.55
2.36
2.30
2.07
1.81
Net Interest Income/
Total Assets
1.51
1.56
1.47
1.89
2.02
2.11
2.27
2.09
2.00
1.85
1.61
Net Fee Income/
Total Assets
0.44
0.58
0.61
0.43
0.47
0.60
0.28
0.27
0.30
0.22
0.20
Net Interest Margin
(NIM)
2.47
2.39
2.64
2.70
2.56
2.59
2.81
2.61
2.44
2.30
1.87
Note: 1) Domestic banks
2) Interest income and non-interest income from second quarter of 2009 x 4/3
3) Core Profit Ratio = (net interest income + net fee income)/total assets
Source: FSS (Monthly Financial Statistics Bulletin)
4
Possible Worsening of Korean Banks' Loan Quality

Loan quality deteriorated from the 3rd quarter of 2008, though has recently
slightly improved

Delinquency ratios could rise from the end of government SME supports and
worsened ability of households to repay loans
- Loan Delinquency Ratio -
- Loan Quality(Unit : %)
250.0
1.90
2.0
205.2
202.7
1.47
175.2
1.22
155.4
150.0
131.4
104.5
1.51
0.72
100.0
0.79
0.82
2.1
2.0
146.3
1.14
2.6 2.6
2.3
1.48
125.3 124.4 125.2
0.84
2.7
2.4
189.3
200.0
(Unit: %)
3.0
1.8
1.4
1.0
1.5
1.4
1.9
2.2
1.9
1.7
1.7
1.9
1.7
1.5 1.5
1.1
0.70
1.0
50.0
0.7 0.7
0.5
0.0
0.0
04'
05'
06'
07'
08.Q1 08.Q2 08.Q3 08.Q4 09.Q1 09.Q2 09.Q3
Ratio Accumulative Allowance for Loan and Leases Losses(against Classified Loan under Substandard(L)
Substandard & Below Loans to Total Loans(R)
Note: Domestic Banks
Source: FSS
0.6
0.7
0.6
0.7 0.7
0.8
0.9
0.6
0.8
0.7 0.8
0.7
0.6 0.6
0.6 0.6 0.6
0.0
08'4
08'6
08'8
08'10
SMEs
08'12
09'2
09'4
09'6
09'8
09'10
Households
Note: 1) Domestic Banks
2) Loans for Banking &Trust Account in Won
3) Principle payment is more than one day overdue.
Source: FSS
5
Escalating Credit Risk of SME Loans

Korean banks have competed to expand SME loans from 2006 as regulation for
mortgage loans tightened

SME loans increased in 2009 due to government supports

However, credit risk of SME loans has risen from 2006 due to the worsening
profitability and financial soundness of SMEs

Non-performing SME loans may rise upon termination of program of government
financial supports
- SME Loans and Growth Rate1) -
(trill.won)
(Unit : %)
(%)
500
22.5
400
17.6
300
- Credit Risk of SME Loans25
427.5 433.8 430.7
411.0 420.3
363.0
296.2
15
13.2
240.1 251.9
04
05
06
07
08
Net Income-to-Sales
Ratio
2.1
1.1
-1.2
-1.4
-4.4
Current Assets
59.9
59.9
59.6
59.1
54.9
Current ratios1)
66.9
66.9
67.9
69.1
82.1
20
10.9
200
10
7.3
6.1
4.8
4.9
100
5
3.3
0
0
04'
05'
06'
07'
SME loans(L)
08'
09.Q1
09.Q2
09.Q3
Growth Rate(R)
09.Q4
Note: 1) Current ratio = current assets/current liabilities
Source: BOK, Financial Stability Report (April 2009)
Note : 1) Commercial & Specialized Banks
Source: Bank of Korea
6
Rising Household Credit Risk from Slump in Household Income
 Regulations slowed mortgage loan growth from 2007
 However, growth was over 10% in 2009 thanks to low rates
 Mortgage loan delinquency ratios are still low, but household credit risk jumped
due to rising unemployment and a reduction in real wages
- Mortgage Loans and Growth Rate1)(trill.won)
(Unit: %)
(%)
14.1
300
265.1
254.4 260.1
239.7 247.3
12.1
200
- Credit Risk of Household Loans-
217.0 221.6
10.7
190.3
169.7
12
10.3
8.1
10.9
10.9
10.6
8
100
4
2.1
0
04'
05'
06'
07'
0
08'
09.Q1 09.Q2 09.Q3 09.Q4
Home Mortgage Loans
Note: 1) Commercial & Specialized Banks
Source: BOK
Growth Rate(R)
2004
2005
2006
2007
2008
Q1
2009
Q2
2009
Q3
2009
Q4
2009
Credit Risk
Index1)
18
0
6
9
25
25
25
16
19
Unemployment
Rate
3.7
3.7
3.5
3.2
3.2
3.8
3.8
3.6
3.3
Real Wage
Growth2)
2.3
3.8
3.4
2.9
-1.2
-5.6
-4.3
-3.1
-
Financial debt/
Financial asset
46.9
45.7
46.8
46.2
50.9
49.5
47.7
46.4
-
Financial debt/
Disposable
Income
122.5 129.4 137.5 145.6 149.9
5
4
5
6
9
-
-
-
-
16
Note: 1) Credit risk = {‘Weight of response of significantly moderate (increase)’×1.0+
‘that of somewhat moderate (increase)’×0.5}-{‘that of significantly
conservative (decrease)’×1.0+‘that of somewhat conservative
(decrease)’×0.5}
2) Real Wage Growth is result of Survey on Wage & Working hours
Source: BOK , Ministry of Labor
7
Contents
I.
Korean Banking Industry : Current Situation and Tasks
II.
2010 Industry Outlook
III.
Future Strategies
8
2010 Industry Outlook: Performance
 Growth and profitability should improve in 2010, though asset soundness is
anticipated to deteriorate
Growth
• Economic recovery ()
Profitability
(ROA)
• Tightening risk management on
SME & household loans ()
Profitability
• Rising interest rates ()
• Growth of asset management market ()
1%
2010E
(Example)
• More competition b/w fin. sectors ()
Asset Soundness
• Greater household and corporate debt servicing
burden due to slump in employment and rise in
interest rates ()
2009E
Nom. GDP Growth
Growth
(Example)
(Loan Growth)
• Worsening loan quality due to bank
managements’emphases on growth ()
9
2010 Industry Outlook: Growth
 Growth would only be moderate due to stricter prudential regulations and
credit risk management
대출자산 증감 추이
-Loans by Type-
• Loan demand boosted by
Upside
Factors
economic recovery
• Improved environment for
[Unit: trill.won, %)
1,000
25.0
22.1
22.5
147.3
19.1
800
overseas business
132.7
• Tightening of credit risk
management on SME loans
229.5
Downside
Factors
• Strengthening of prudential
regulations on mortgage loans
• Strengthening of regulations on
capital and leverage ratios by G20
239.7
8.1
8.5
0
334.6
42.6
07.2/4
144.0
143.5
254.4
260.1
265.1
13.2
221.6
400
200
145.1
20.0
141.9
600
217.8
148.8
363.0
2.1
50.4
07.4/4
398.5
5.4
10.9
427.5
10.9
15.0
10.6
10.0
433.8
430.7
411.0
7.3
6.1
5.0
4.8
64.8
80.7
77.7
79.7
75.5
08.2/4
08.4/4
09.2/4
09.3/4
09.4/4
LEs
SMEs
Home Mortgage loans
Households(Except Mortgage loans)
Growth rate of SMEs Loans
Growth rate of Hoem Mortgage loans
0.0
Note : 1) Commercial & Specialized Banks
2) Y.o.Y. Growth
Source: BOK
10
2010 Industry Outlook: Profitability
 Recovering profits due to the rise in interest rates and the economic
recovery
Positive Factors
Interest
Income
• Rise in interest
rates
Negative Factors
- Profitability Indices -
• Limited by ind.
competition
(Unit: tril. won, %)
9.0
• Economic
recovery
2.76
8.0
7.0
6.0
NonInterest
Income
2.9
2.77
• Growth in asset
management market
• Settlement services
by nonbank fin. firms
• Demand for
investment advisory
and discretionary
investment services
• Enhanced investor
protections and loss
of trust from fund
investors
6.0
5.7
2.72
5.9
2.73
6.4
7.5
2.57 2.53
2.55
6.4
6.1
6.0
6.3
5.8
5.3
5.0
4.0
2.7
2.67
4.1
3.5
2.3
2.19
3.2
2.04 2.05
3.0
2.0
1.0
1.4
0.6
0.3
0.9
0.6
1.31.4
1.3
1.0
1.4
0.8
1.8
1.3
2.1
1.9
1.8
1.2
0.6
2.5
1.2
1.7
0.7
0.0
0.0
1.5
07.1/4 07.2/4 07.3/4 07.4/4 08.1/4 08.2/4 08.3/4 08.4/4 09.1/4 09.2/4 09.3/4
Loan Loss
Provisions
• Progress in
corporate
restructuring and
decline in corp.
distress
• Potential rise in
credit risk in
mortgage and
SME loans
Interest Income
Non-Interest Income
Provisions
NIM
Note: 1) Commercial Banks
2) NIM is cumulative
Source: FSS
11
2010 Industry Outlook: Asset Soundness
 Slight deterioration in quality of household & SME Loans
- Loan Delinquency &NPL Ratios• Strengthening prudential
regulation
Positive
Factors
• Being alert on mortgage and
SME loan credit risk
• Improvement in corporate
profitability due to economic
recovery
(Unit:%)
2.50
2.4
2.00
1.50
1.28
1.00
1.8
1.8
1.7
1.2
1.2
1.5
1.3
1.1
1.54
1.16
1.2
0.90
0.73
0.77
1.7
1.56 1.53
0.81
0.71
0.50
0.6
0.4
Negative
Factors
• Weak employment and decline
in real household income
• Roll-back of favorable liquidity
supports for SMEs
0.5
0.4
0.4
0.5
0.6
0.4
0.4
0.00
2005
2006
2007 08.1/4 08.2/4 08.3/4 08.4/4 09.1/4 09.2/4 09.3/4
Substandard & Below Loans to Total Loans
Delinquency rate of SME Loans
Delinquency rate of Home Mortgage Loans
Note : 1) Commercial Banks
Source: FSS
12
2010 Industry Outlook: Capital Adequacy
 Quantity and quality of capital should both improve due to enhanced capital
regulations, improved profitability, and gearing-up for M&A activity
- Tier I & BIS Ratios• International efforts based on G20
(Unit: %)
15.00
recommendations to build high quality
14.00
capital, such as common equity
13.00
12.00
14.25
13.40
12.43 12.31
11.00
• Improved bank profits that can be
retained
opportunities like M&A
11.95
10.97 11.16
10.66
10.50
9.00
7.00
• Preparations for external growth
12.72
10.00
8.00
14.64
10.94
9.72
8.74
9.01
8.52
8.45
7.89
8.24
8.24
6.00
2005 2006 2007 08.1/4 08.2/4 08.3/4 08.4/4 09.1/4 09.2/4 09.3/4
BIS Ratio
Tier1 Captial
Note : 1) Commercial banks
2) Basel II since 2008
Source: FSS
13
Contents
I.
Korean Banking Industry: Current Situation and Tasks Ahead
II.
2010 Industry Outlook
III.
Future Strategies
1.
Strengthening Loan Management and Profit Generating Capacity
2.
Preparing for Stricter FSB Prudential Regulations
3.
Preparing Industry for Structural Change
4.
Overseas Strategies
14
Strengthening Loan Management
• Potential rise in SME loan losses due to roll-back of SME
supports, such as Fast Track
SME loans
• Leveling-up allowances for loan losses and/or capital depending
on estimated credit losses
• Heightening screening process when making loans
• Over 10% increase of mortgage loans during 2009
Household Loans
• Household credit risk may rise due to weak employment,
declining real income, rising CD yields, and increasing financial
debt
• Alleviating loan losses by debt restructuring based on
evaluation of households’ debt-servicing capacity
15
Improving Profit Generating Capacity

Improve profit generating capacity by enlarging sources of interest and non-interest
income and by strengthening core competencies
Interest Income
• Pricing legitimate loan rates by reflecting
credit risk
recruiting loan officers from corporate
sector and data profilers of retail
customers
• Developing new products to grow
core deposits
• Constraining unnecessary
competition among banks
Core Competence
• Fostering experts by enhanced human
resource management such as
recruitment by job families
• Pursuing synergy by M&A and crossselling
Non-Interest Income
Improvement
of Profit
Generating
Capacity
• Filling demand for pension and
discretionary inv. services
• Regaining trust of fund investors
• Rationalizing fee structure by
levying fees on beneficiaries of
services
New Profit Centers
• Being global by expanding abroad
16
Contents
I.
Korean Banking Industry: Current Situation and Tasks Ahead
II.
2010 Industry Outlook
III.
Future Strategies
1.
Strengthening Loan Management and Profit Generation Capacity
2.
Preparing for Stricter FSB Prudential Regulations
3.
Preparing Industry for Structural Change
4.
Overseas Strategies
17
Quality, Consistency and Transparency of Bank Capital

Improving the Quality of Capital  Enhanced Loss Absorption Capacity
(To - Be)
Tier I Capital
• Intangibles such as goodwill
• Investments in own shares
or treasury stock
• Deferred tax assets
(As - Is)
Tier I Capital
Other Tier I
(Non-Cumulative
Perpetual Preferred
Stock)
Other Tier I
Deduction &
Adjustment
• Investments in the common
stock of other financial
institutions
• Shortfall of stock provisions
to exp. losses under IRB
approach
Retained Earnings
Core Tier I
Capital
Voting
Common Equity
Predominant Test
Voting Common
Voting Common Equity
Equity
+ Retained Earnings
+Retained Earnings
Tier I Capital
18
Quality, Consistency and Transparency of Bank Capital

Deductions & Adjustments to be taken from common equity

Effect of two different methods (figures below)
<From Other Tier
<From Common Equity>
I>
3.2%
3.8%
Other Tier I
0.7%
Common
Equity
3.8%
 Common Equity Ratio = 3.8%
Impact
▶
▶
Deductions &
Adjustments
2.5%
Other Tier I
3.2%
Common Equity
1.3%
 Common Equity Ratio = 1.3%
Tier 1 capital ratio (10.7% in Q3 2009) is already high, of which
common shares and retained earnings together are over 90%
Impact would be relatively small but cost of hybrid capital would rise
19
Pro-Cyclicality of Bank Capital

Counter-Cyclical capital buffers & provisions based on expected loss
Minimum Regulatory Capital Fluctuations
Business
Cycle
Counter-Cyclical Capital Buffers
Business
Cycle
Peak
Trough
Trough
Counter-Cyclical
Capital Buffers
Minimum
Regulatory
Capital
Impact
Peak
Contingent Capital
Minimum
Regulatory
Capital
▶
In the short-term, impact would be minor but Korean banks need to establish
a strategy to manage capital buffers, balancing asset growth with capital increases
20
Liquidity and Leverage Regulations
Two Regulatory Standards for Liquidity Risk
Short-Term
 Liquidity Coverage Ratio (>100%)
Stock of High-Quality Liquid Assets
=
Net Cash Outflows over a 30-Day Time Period
Long-Term
 Net Stable Funding Ratio (>100%)
=
Available Amount of Stable Funding (Sources)
Required Amount of Stable Funding (Uses)
Measuring the sufficiency of a stock of high
quality liquid assets to meet short-term
liquidity needs under a specified acute stress
scenario
• factors depending on reliability of equity
and liability financing over one year
• factors depending on liquidity
characteristics of each assets held
Introduction of Leverage Regulations
 Leverage Ratio =
Asset Categorization
Capital Categorization
• Total exposure: simple, non-risk-based,
gross exposure
• Predominant form of Tier 1 (common
 Intent to be migrated to a Pillar I (mandatory)
▶
Impact
▶
shares and retained earnings) and Tier 1
Korean banks will need to conduct more advanced liquidity risk
management practices
Leverage regulations will not make a big impact because Korean banks have
well-managed equity-to-assets ratios which are similar to leverage ratios in nature
21
Timeline of and Preparations for Enhanced Regulation
Preparations for Enhanced Regulation



Consultative Documents of BCBS were Submitted at the End of 2009
•
Each country conducts QIS (quantitative impact study) during first half of 2010
•
Calibrated level- and quality-standards will be set by the end of 2010
Applying Enhanced Regulation when Recovery is Certain: End-2012 Target
•
Phasing-in ensuring that implementation is consistent with financial market
stability and sustainable economic growth
•
Grandfathering clause for government stakes acquired during the crisis
Korean Banks Need to Heighten Adherence to New Prudential Standards in a
Swift and Orderly Manner that Considers the Stability of the Banking System
•
Adherence to global standards is inevitable
22
Contents
I.
Korean Banking Industry: Current Situation and Tasks Ahead
II.
2010 Industry Outlook
III.
Future Strategies
1.
Strengthening Loan Management and Profit Generation Capacity
2.
Preparing for Stricter FSB Prudential Regulations
3.
Preparing Industry for Structural Change
4.
Overseas Strategies
23
Possible Structural Changes to Korean Banking Industry

Restructuring through sale of govt. stakes in some banks is highly likely
•
Privatization of Woori Financial Holdings and KDB are being pursued by
government and KEB could be up for sale
•
Banks will look to M&A to become a market leader, obtain economies of
scale, and expand into overseas markets
Things to be Considered

Merits and disadvantages of selling domestically or to foreigners

Preventing a monopoiistic industry structure

Upholding stability of financial system

Maximizing recovery of public funds when govt. stakes are sold

Enhancing competitiveness of banking industry

Preparing for shrinkage of SME loans

Enlarging services to financial consumers
24
Contents
I.
Korean Banking Industry: Current Situation and Tasks Ahead
II.
2010 Industry Outlook
III.
Future Strategies
1.
Strengthening Loan Management and Profit Generation Capacity
2.
Preparing for Stricter FSB Prudential Regulations
3.
Preparing Industry for Structural Change
4.
Overseas Strategies
25
Obstacles to Overseas Expansion
Inferiority in Scale and Expertise
• Lacking expertise in M&A and self-account transactions and being inferior to global banks in terms of
personnel and management skills
Lacking in Localization
• Locals are just 38.8% of customers at for. branches of Kor. banks, and local employees under 50% (2007)
• 93.7% of employees at Korean offices of foreign banks are Korean
Herding on Expansion Targets
• 62.1% of foreign offices were in Asia at the end of the third quarter of 2009
• Flocking to a specific country could result in self-destructive over-competition
Insufficient Research Capabilities
• Unable to identify target markets, methods of entry, etc.
Regulations on Both Sides
• Domestic regulations hinder going abroad (ex: restricted role of PEF for restructuring)
• Emerging Asian countries keep entry barriers to protect their banking industries
26
Strategies for Expanding Overseas Business
Enhancing Core Competency
Finding Niche Markets
 Fostering financial specialists
 Differentiating from global banks
 Developing financial education
programs
 Finding niche business areas and niche
customers
 Globalizing research functions
 Benchmarking successful cases like
Jefferies & Co.
Coordination with Local Banks
 Networking through joint ventures
 Screening potential M&A targets
through business alliances and
personnel exchange
Active Localization
 Stepping-up scale of M&A by PMI
after acquiring small banks
 Hiring local financial experts
27
Thank You!