Banks face double whammy on falling key rates
Local banks are facing tough times, suffering from falling profitability and worsening financial soundness following a couple of rate cuts by the central bank amid the deepening global downturn.
The Bank of Korea (BOK) cut its key rate by 0.25 percentage points Oct.16 to a record-low 1.25 percent, the second such move this year, after lowering the rate from 1.75 percent to 1.5 percent in July.
The credit easing is reducing bank’s interest rates, which in turn affects their net interest margin (NIM). The margin, the difference between the rate a bank charges for loans and what it pays for deposits, is considered a measure of profitability, and has been falling in line with the BOK’s cuts.
The four major commercial banks — Shinhan, KB Kookmin, Woori and KEB Hana — all saw their NIM fall by between 0.01 and 0.05 percentage points in the second quarter from the previous one.
As such, it is inevitable that their profitability will fall further after the rate cut a week ago.
To make up for the fall in the NIM, the lenders have sought to increase non-interest income but incidents involving controversial derivative-linked products that incurred huge losses for individual investors have curbed this.
Investors in derivative-linked funds (DLFs) including those tied to yields of German treasury bonds were estimated to have lost up to 351.3 billion won ($320 million), as of late September, due to falling central bank interest rates.
Banks have now stopped the sale of high-risk options as the financial authorities are moving to strengthen regulations to protect individual investors.
Financial soundness is another key issue for the banks. There are concerns that non-performing loans will rise as businesses are reeling from falling sales caused by a decline in exports.
According to data from the BOK, a total of 3,236 companies or 14.2 percent of those that underwent external audits last year were on the verge of bankruptcy, up from 3,112 in 2017.
The portion of such marginalized firms among both conglomerates and small-and medium-sized enterprises (SMEs) grew by a respective 10.6 percent and 14.9 percent.
Analysts said the increase in the number of troubled firms will affect banks’ earnings.
“The combined net profit for domestic banks is expected to reach 13.9 trillion won this year. But the figure is expected to fall to 13.4 trillion won in 2020 due to several factors, including falling net interest margins,” SK Securities analyst Koo Kyung-hoi said in a recent report.
“Local banks’ average return on equity is also set to fall, from 9.6 percent in 2018 to 9.1 percent this year.”
A local bank official said “It’s a given that when the interest rate falls, banks face deteriorating circumstances.”
“Taking this into account, we are devising ways to diversify sources of profits and increase cost efficiency,” he said.