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South Korean bank margins may stabilize as central bank signals end to loosening

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South Korean bank margins may stabilize as central bank signals end to loosening

Commercial banks in South Korea are likely to see their net interest margins stabilize after the nation became the first in Asia to raise its benchmark interest rate on a stable economic outlook.

The Bank of Korea raised its base rate by a quarter of a percentage point to 0.75% on Aug. 26, according to the central bank's monetary policy statement. The benchmark rate was cut to 0.5%, the lowest on record, in May 2020 to support the economy amid the COVID-19 pandemic. It had earlier slashed the rate by half a percentage point in March 2020.

"The rate hike cycle is positive for banks in putting a floor to NIM and generating bread-and-butter interest income" for banks, said Gary Ng, senior economist at Natixis. The reversal of the monetary cycle, however, may not cause a sharp rebound in bank NIMs, Ng said, pointing to the previous round of rate hikes between 2016 and 2018 that only had a limited effect in the key measure of banks' earnings from their main lending business.

The aggregate NIM of South Korean banks had climbed to 1.98% in 2018 from 1.89% in 2016, according to data from S&P Global Market Intelligence. After the central bank eased policy, aggregate NIM fell to 1.76% in 2020 from 1.90% in the previous year, the data show.

NIM at KB Financial Group Inc. and Woori Financial Group Inc., two of South Korea's largest banks, rose to 1.90% and 1.66%, respectively, in the quarter ended June 30, from 1.81% and 1.62% in the previous quarter. Shinhan Financial Group Co. Ltd., meanwhile, saw its NIM fall to 1.87% from 2.04%.

The increase in the central bank's benchmark rate "is unlikely to have a big impact on margins at commercial banks" in South Korea, said Takahide Kiuchi, executive economist at Nomura Research Institute in Tokyo. "This is not a tightening of the monetary policy but a decline in the loosening of it."

The Bank of Korea's rate-hike decision will turn the focus on other major central banks in Asia, especially countries that have largely managed to control the spread of the disease, including China and New Zealand. The most keenly awaited event this week is the U.S. Federal Reserve's annual economic policy symposium in Jackson Hole, Wyo., where investors will look for clues on the Fed's plan to reverse the historic bond-buying program in Chairman Jerome Powell's speech on Aug. 27.

Central banks in Asia may diverge on monetary policy normalizing, especially its timing, though rate hikes are starting to feature in their meetings. While South Korea's decision was driven by its concerns around financial imbalances and the nation's solid economic rebound from the pandemic supported by the tech upcycle, elsewhere in Asia "growth recoveries are quite divergent and policy priorities also differ," said Sonal Varma, Nomura's chief economist for Asia excluding Japan.

"Hence, we expect more policy divergences based on local idiosyncratic factors," Varma added.

With rates at record lows, banks across the world have leaned on alternative sources of income such as fees from wealth management and commissions to counter falling interest incomes. Lenders have also faced a worsening of their asset quality, which often required them to step up provisions for bad loans. However, most governments have announced fiscal measures, which included an emergency fund for small and medium-sized enterprises in South Korea and guarantees on loans. That helped cushion the impact of the pandemic on bank earnings.

The Bank of Korea expects the local economy to continue its recovery as private consumption is forecast to improve gradually, helped by vaccinations and a supplementary budget, while exports and investment are expected to sustain their buoyancy. The central bank said GDP growth this year is projected to be around 4%, consistent with the forecast in May. However, consumer price inflation may exceed the prior forecast, it said.

Morgan Stanley expects the South Korean central bank to raise the benchmark rate later this year and once more in the first quarter of 2022, taking the measure to 1.25%.

"Following the earlier-than-expected rate hike this meeting, we are rejigging the timing of the next few hikes. We expect [Bank of Korea] to hike the policy rate every alternate meeting, given its guidance of a gradual adjustment," the investment bank said in a note.