Korean banks’ earnings dilemma: More profits, more responsibility
Heightened pressure puts banks in tricky position for growth, says Fitch ratings director
Korean banks may face diminishing profitability due to mounting pressure to take on social responsibilities amid the country’s slowing economic growth, a senior official at global credit appraiser Fitch Ratings said.
Commercial banks, often criticized for making money from excessively high interest rates, are facing stronger pressure from local authorities to return a portion of profits to the provision of public goods.
“From the operating environment side, the pressure to commit to social responsibility is growing, negatively impacting profitability,” Chang Hea-kyu, senior director of Asia-Pacific Banks at Fitch Ratings, said in an interview with The Korea Herald in Seoul on Thursday.
In March, Korea’s Financial Supervisory Service advised banks to partly compensate for the investors’ losses incurred from equitylinked securities, tied to the Hang Seng China Enterprises Index in Hong Kong.
Banks also had to shell out a combined 2 trillion won ($1.45 billion) in December for the government’s “mutual growth” push to support socially vulnerable groups, including small businesses and financially underserved individuals.
The increased a damp on the banks.
For instance, Korea’s top five banks saw their net profit drop by 16.7 percent in the first quarter as they compensated for the ELS investment losses. In the wake of the ELS crisis, the operating standards for the sales of financial products are likely to be further tightened, pressure casts profitability of meaning less profits for banks.
“The pressure may grow further,” Chang projected.
But while the authorities’ push on banks could lead to stagnant profitability, it could vouch for the lenders’ credibility as it proves their close relationship with the government.
According to the Fitch Ratings’ framework, ratings for banks are decided by mainly two factors: a viability rating, which is the bank’s standalone credit profile, and a government support rating, which evaluates the likelihood of receiving external support when needed.
“If Korea undergoes a major crisis and the big banks face difficulty, the government is unlikely to look away. The ‘too big to fail’ logic comes into play here,” Chang explained.
“The main creditors of banks are retail depositors and we think the government has the moral obligation to protect them after the local authorities’ intervention (such as cash distribution schemes),” he said.
Despite the strong intervention, Korea’s top four lenders — KB, Shinhan, Hana and Woori — are all placed on the sixth-highest “A” level on the 20-notch of Fitch’s long-term issuer default rating table.
But Chang views that the local banking sector is in a tricky situation, facing strong headwinds.
The room for growth is limited for Korean banks as the country has hit a standstill in its economic growth.
“Typically, the banking business grows when the economy grows. When the economy contracts, the opportunities to make money lessen,” he said.
The country’s changing demographics also pose risks. With its fertility rate hitting a record low of 0.72 last year, depopulation is on the horizon for Korea.
“In an aging society, who would borrow money? The growth potential on the domestic side remains limited,” Chang said.
Expansion into overseas markets also poses risks for the lenders in terms of credibility.
“Massive overseas expansion could bring down the credibility of the banks as venturing out to emerging countries with weak financial infrastructure could affect the viability rating,” he said.
The banks would need a major breakthrough to be both lucrative and socially responsible, Chang viewed.
“Over the last 70 years, the Korean economy has grown with high leverage. The banking sector is currently placed in a very challenging environment indeed. We will have to see how the banking industry overcomes the difficulties,” he said.