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Korea's Major Banks Can Sustain Capitalization Despite Tougher Conditions

HONG KONG (S&P Global Ratings) Feb. 13, 2020--Major Korean commercial banks are set to prioritize risk management in 2020 as the coronavirus outbreak adds to global economic pressures. S&P Global Ratings believes the banks have adequate capital buffers to absorb some pressure on asset quality and profitability.

Major Korean commercial banks have prudent risk management, which is reflected in their low average nonperforming loan (NPL) ratios and credit costs over recent years. This will likely help the banks weather periods of weakening profitability, as we expect in 2020.

The solid 2019 financial performance of Korea's four major commercial banks--namely, Kookmin Bank (A+/Stable/A-1), Shinhan Bank (A+/Stable/A-1), KEB Hana Bank (A+/Stable/A-1), and Woori Bank (A/Positive/A-1)--was broadly in line with our expectations. The four banks' average return on average assets (ROAA) was about 0.59% in 2019, or 0.62% after adjusting for the one-off accounting loss at Woori Bank related to the transfer of Woori Card Co. Ltd. to the parent holding company. This is a modest slip compared with 0.65% in 2018 (2017: 0.60%), given weaker domestic economic growth, weighed on by trade tensions between the U.S. and China as well as Korea and Japan.

In 2020, we project profitability will further decline, with an average ROAA at about 0.55% for the four major commercial banks. Persistent low interest rates will press down on net interest margins, and credit costs should pick up modestly amid sluggish economic growth and diminishing provisioning reversals. We also anticipate modest pressure on non-interest income due to sluggish customer demands on financial products and some competition from fintech companies in niche areas such as money transfers and other simple transaction-based services.

These trends mostly follow on from last year, which saw a mild contraction of net interest margins. Average credit costs for the four major banks--as measured by provisioning expense to total loans--remained low at about 10 basis points (bps) in 2019 compared with about 8 bps in 2018. The average credit cost in 2015-2017 was about 30 bps. The banks' average NPL ratio has improved over the past several years to historically low levels of about 0.4% at the end of 2019 from about 0.5% at the end of 2018 and 1.2% at the end of 2015.

The creditworthiness of Korea's four major banks will be supported by their sustaining capitalization amid moderate loan growth in 2020. This also considers the government's tightening measures on the property market which will likely result in a slower growth in household loans. We project the banks will manage their local-currency loan-to-deposit ratio at marginally below 100%, reflecting the higher risk weightings on household loans, effective from January 2020. We estimate an annual loan growth of around 4%-5% in 2020 down from about 6% in 2019 and 8% in 2018.

Banks will likely focus on strengthening their internal controls related to product design and sales processes. Increasing regulatory focus on consumer protection and misselling of financial products should lead to lower promotion of and customer demand for these products. This follows a recent incident where derivative-linked funds sold by some banks incurred losses for customers. Some banks may also compensate for their misselling of currency-linked derivative products to corporates mostly sold during 2007-2008, as suggested by financial regulators. That said, we believe the financial impact from potential compensation expenses will not likely be significant relative to their earnings.

We expect the major commercial banks to sustain their strong business presence backed by their established internet and mobile banking platforms and longstanding customer relationships against some competition from the internet-only banks. Korea's two internet-only banks have a small presence so far and focus on the unsecured retail loan market. They collectively comprise only about 0.5% of the loans and deposits in the banking system as of September 2019. That said, the growth of internet-only banks could intensify competition, putting some pressure on the banks' net interest margins.

We anticipate a gradual expansion of overseas business as the banks seek long-term growth opportunity and business diversity; especially, for example, in Southeast Asian countries where Korean exporters have production base. In 2019, KEB Hana Bank invested in one of the largest banks in Vietnam and Kookmin Bank also proposed to acquire one of the largest microfinance deposit-taking institutions in Cambodia. The size of these investments were modest, compared with their asset and capital base. That said, an aggressive organic or inorganic growth in countries with relatively high economic risks could add burden to the banks' capitalization and risk management, in our view.

We expect major commercial banks to maintain stable funding and liquidity profiles in the coming few years underpinned by their large and stable domestic customer deposit base. The banks will also likely manage foreign currency funding and liquidity risks despite a potential increase in global financial market volatility amid the coronavirus outbreak; they have a good risk management track record and regulatory oversight has tightened. The banks' foreign currency funding represents about 12% of total funding as of September 2019.

We have stable outlooks on the ratings of Kookmin Bank, Shinhan Bank, and KEB Hana Bank. The rating on Woori Bank is one notch lower than the other three commercial bank peers, partly due to the bank's weaker track record of in managing credit risks. That said, Woori Bank's risk management has improved in recent years. We have a positive outlook on Woori Bank and could upgrade the bank if it sustains its improved risk management comparable to that of major commercial bank peers, and at the same time, maintains an adequate capital buffer amid the group's potential nonbanking business expansion over the next 18-24 months.

Related Research

  • Global Credit Conditions: Coronavirus Casts Shadow Over Credit Outlook, Feb. 11, 2020
  • Coronavirus To Inflict A Large, Temporary Blow To China's Economy, Feb. 7, 2020
  • Korean Banks Will Likely Weather Headwinds Arising From Coronavirus, Feb. 5, 2020
  • KEB Hana Bank, Dec. 16, 2019
  • Woori Bank, Dec. 13, 2019
  • Kookmin Bank, Dec. 12, 2019
  • Shinhan Bank, Dec. 12, 2019
  • The Future Of Banking: Korean Banks Surf The Wave Of Tech Disruption, Dec. 10, 2019
  • Banking Industry Country Risk Assessment: Korea, Aug. 27, 2019

This report does not constitute a rating action.

S&P Global Ratings, part of S&P Global Inc. (NYSE: SPGI), is the world's leading provider of independent credit risk research. We publish more than a million credit ratings on debt issued by sovereign, municipal, corporate and financial sector entities. With over 1,400 credit analysts in 26 countries, and more than 150 years' experience of assessing credit risk, we offer a unique combination of global coverage and local insight. Our research and opinions about relative credit risk provide market participants with information that helps to support the growth of transparent, liquid debt markets worldwide.

Primary Credit Analyst:Emily Yi, Hong Kong (852) 2532-8091;
emily.yi@spglobal.com
Secondary Contacts:HongTaik Chung, CFA, Hong Kong (852) 2533 3597;
hongtaik.chung@spglobal.com
Daehyun Kim, CFA, Hong Kong (852) 2533-3508 ;
daehyun.kim@spglobal.com
Scott Han, CFA, Hong Kong (852) 2532-8022;
Scott.Han@spglobal.com

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