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The Future Of Banking: Korean Banks Surf The Wave Of Tech Disruption

Korean banks are pro-innovation and quick to adopt new technology. They have established a range of digital and mobile banking services, taking advantage of the country's high internet and smartphone penetration rates. S&P Global Ratings believes incumbents will continue to dominate the banking scene, even as the market opens wider to digital competition.

Korea eased regulations for internet-only banks early this year, but effective barriers to entry remain high. This is because non-financial companies cannot fully own internet-only banks, and new internet-only bank applicants must pass through a stringent review process. Under a regulatory sandbox announced in the spring of 2019, fintech companies can apply for waivers to financial regulations in offering new services. While this opening will raise competition in the banking industry, we believe regulators will continue to prioritize stability.

Nonetheless, competition from internet-only banks or fintech companies could put modest pressure on the incumbent banks' revenues in some niche areas. The country's internet-only banks will likely focus on the unsecured retail-loan segment. Fintech companies will likely continue to specialize in money transfers and other simple transaction-based services that have not traditionally been major revenue sources for the banks.

Established Internet And Mobile Banking Platforms In Korea

We expect incumbent Korean banks to sustain their competitiveness even as the sector goes more digital. Traditional banks have already established a robust range of internet and mobile banking services. The banks' longstanding relationships with retail customers in a mature banking market will also present a high operational barrier for new entrants to compete, in our view.

By the time the first internet-only banks started operations in 2017, most of the incumbent banks had already long offered internet and mobile banking services using smartphone. Banks will need to continually improve their service quality, however, in order to hold on to customers as demand for digital services expands. Korean banks had a total of 143 million retail internet and mobile banking accounts as of end-June 2019, indicating an average of 2.8 accounts per citizen (see chart 1). Just under 8% of money transfers and withdrawals were made at bank branches or offices in the first half of 2019, compared with 57% made via internet banking. Automated teller machines (29%) and telebanking (7%) accounted for the remainder.

Chart 1

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An Opening To Open Banking And Third-Party Collaboration

Banks will likely remain active in adopting changing technology to improve service quality. Much of this will come from internal efforts to stay on top of technology trends, including through partnering with fintech companies. Regulatory initiatives will also force banks to meet new technology challenges--such as the freshly rolled out open-banking system.

Open banking presents both opportunity and challenge for Korean incumbents. It will allow customers to access multiple accounts, across different banks, on a single platform. Greater transparency of customer financial profiles will in turn enable banks to offer tailored-products suited to customers' needs. Innovative services from third-party fintech companies using data from banks will benefit customers, in our view, helping banks to find and acquire new customers. That said, aggregation of data will also increase price transparency which could lead to higher competition to keep their customers. We also expect data-security risk and related costs to increase as banks share customer data with third parties.

Developments in the open application program interface (API) indicate that regulators are committed to fostering innovation in the banking system. A pilot-test for open banking services by 10 domestic banks began on Oct. 30, 2019, with expected full-scale implementation from Dec. 18, 2019. All fintech companies offering settlement services and all domestic banks (including the two internet-only banks) are allowed to join the open banking system, which is centrally governed and operated by the Korea Financial Telecommunications and Clearings Institute. Korea's model is similar to that of U.K. where banks have a multilateral arrangement with third-party service providers, and unlike Hong Kong's, where banks negotiate with each third-party service provider bilaterally. We expect Korea's centrally governed model to be more effective in facilitating the expansion of the digital ecosystem.

Apart from open banking, individual banks will continue to improve their product and services by collaborating with fintech companies. This could raise higher investment costs in the short term, but produce cost-saving or revenue-generating opportunities in the longer-run. Major banks have already built their own open API platforms to provide more comprehensive financial services to customers including payments, remittances, peer-to-peer lending, and asset management. Some banks also created so-called "fintech labs" through which they fund fintech startups, looking for potential technology that can enhance their product offerings or facilitate back-end operations.

Evolving Regulatory Framework To Foster Innovation

We believe the stability of the banking system will remain a priority even as regulations ease to foster innovation. Two key regulatory revisions implemented this year open the banking sector to more competition from tech companies: in January, rules for internet-only banks eased, and in April, a regulation sandbox was introduced for the financial sector. Moreover, government moves to encourage tech company start-ups should also feed through to the finance sector. That said, the gatekeepers are still showing caution, in our view. The Financial Services Commission (FSC) rejected two new applicants for internet-only banking licenses in May 2019, for example, after reviewing various factors such as business innovation, eligibility of the largest shareholder, and funding capability. The FSC received three applications for new preliminary licenses for internet-only banks in October 2019, and plans to announce the results sometime before the end of the year.

Internet-only banks: eased but still not easy

The revised regulation on the ownership of internet-only banks, introduced in January 2019 is aimed at promoting internet-only banks through more active participation from tech companies. This is turn should facilitate technological developments and benefit customers. While ownership rules have eased, full ownership in internet-only banks by non-financial companies is still not allowed and the regulatory requirements for new entrants remain stringent, in our view.

The relaxed rules allow for nonfinancial companies focusing on information and communication technology business to own stakes of up to 34% in internet-only banks. This is much higher than ownership limits for incumbent banks. Under the bank law, nonfinancial companies are prohibited from owning more than 4% voting rights in a nationwide commercial bank (15% for regional bank) while stakes of up to 10% are permitted upon approval from the FSC. Nonetheless, regulators have shown forbearance to the segment; for example by giving the first two internet-only banks a grace period until end-2019 to start phasing in Basel III capital regulations.

The sandbox and other fintech openings

We believe the evolving regulatory framework promotes the overall fintech industry and also enables the banks to better prepare for digital transformation. Banks could also benefit from the regulatory sandbox, implemented in April 2019, because it will incentivize them to introduce innovative banking services to increase convenience for customers. Examples of this trend include Kookmin Bank's virtual network operator business that will simplify customer's mobile banking authentication process, and Woori Bank's drive-through foreign exchange and withdrawal services. Both services were included in the first batch of approvals given by regulators in spring 2019.

That said, fintech companies could add alternative services that intensify competition in the banking industry. For instance, mobile platforms that provide comparison of banks' loan products and the interest rates.

Based on another two-year trial regulatory easing that began in October 2019, banks can get accelerated approval to make strategic investments in, or directly run fintech-related business on their own. They also have an expanded scope for such investments. This, in our view, should advance the banks' technological capabilities. It could also benefit fintech companies by helping them find secure funding sources from financial services firms.

Competitive Landscape Makes For Stable Outlook

Incumbent banks will remain the dominant players in loans and deposits in Korea's banking system. This is despite some inroads by internet-only banks, especially on retail lending, and fintech companies' specialized financial services such as money transfers, account inquiry services, and settlement services. The market share in loans and has been fairly stable over the past several years, backed by the banks' solid business franchises and market positions in a highly competitive industry with similar product offerings.

The industry is dominated by four nationwide commercial banks and two policy banks: Kookmin Bank, Woori Bank, KEB Hana Bank, Shinhan Bank, NongHyup Bank, and Industrial Bank of Korea. These banks collectively account for around 60% of market share in total loans and deposits of the deposit-taking institutions as of June 2019 (see charts 2a and 2b). Six regional banks also have robust business presences in their respective regions.

Internet-only banks will unlikely present significant threat in the coming few years. This is owing to the incumbents' established internet and mobile banking platforms and their longstanding relationships, especially with high credit profile retail customers. Banks are also continuing efforts to innovate. For example, in response to similar offerings by internet-only banks, major banks have also introduced several retail-loan products that customers can access through their mobile phones with quicker approval process. The internet-only banks will likely focus on the unsecured-retail loan segment and aim to gradually increase loans that charge mid-to-high interest rates.

Chart 2a

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Chart 2b

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Note to charts 2a and 2b: *Non-banks include merchant banks, asset management companies, trusts, mutual savings banks, credit unions, mutual credit firms, and community credit coops. Commercial banks include national banks, regional banks and foreign bank branches. Source: Bank of Korea, Financial Supervisory Service.

Korea's two internet-only banks--Kakao Bank and K-Bank--have a small presence thus far. They collectively comprise only about 0.5% of the loans and deposits in the system as of September 2019, since their launch in 2017. Their growth is somewhat constrained by capital requirements; it can be hard to increase their capital bases meaningfully in part due to regulations around bank ownership by nonfinancial companies. Recent easing of the regulations help, but complicated shareholding structures still make it difficult for these banks to grow their capital bases in a timely manner. While Kakao Bank has managed a small net profit since the first quarter of 2019, K-bank is still making net losses.

Chart 3a

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Chart 3b

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The growth of internet-only banks and potential new entrants could intensify competition over the next three to five years as the new entrants scale up. We don't believe internet-only banks will be a game changer to the competitive landscape, but they could provide some pressure on banks' net interest margins.

In our view, interbank-only banks are able to offer relatively competitive deposit rates for customers. This, in our view has allowed for rapid growth in their short operating history. The underwriting and risk management capabilities need to be tested given this rapid growth.

Potential business disruptions from fintech companies will also likely be limited, although this could add some modest pressure on incumbent banks' fee income from simple transactions such as money transfers. Korean banks heavily rely on net interest income, which accounted for about 85% of total revenues during the first half of 2019.

So far, fintech companies, such as Viva Republica (with the platform named Toss) or Kakao Pay, have made the biggest inroads into small-amount money transfers. This is gaining popularity especially among young-generation customers, who can easily transfer money using their mobile-phone numbers instead of bank-account numbers. That said, incumbent banks already offer money transfers without fees for major customers, through their internet and mobile banking services.

We anticipate incumbent banks will try to continue strengthening their noninterest income to diversify their revenue sources, but transaction-related fees have not been a major revenue source. This is in part due to high competition among banks which has led to the reduction of fees across the industry. We also expect fintech companies have low potential to disrupt the payment system, given Korea's high credit card and internet / mobile banking penetration. This is in contrast to countries such as China, where fintech firms quickly filled the void of payment services provided by financial institutions.

Related Research

  • The Future Of Banking: One Year On, Hong Kong's Open Banking Initiative Hits A Roadblock, Oct. 3, 2019
  • Banking Industry Country Risk Assessment: Korea, Aug. 27, 2019
  • The Future Of Banking: Virtual And Vital--Online-Only Banks Aim To Transform Taiwan Banking, Aug. 1, 2019
  • The Future Of Banking: Virtual Banks Chase The Dream In Asia-Pacific, July 17, 2019
  • Singapore Follows A Measured Approach To Virtual Banking, July 3, 2019
  • The Future Of Banking: Will Retail Banks Trip Over Tech Disruption?, May 14, 2019
  • Tech Disruption In Retail Banking: China's Banks Are Playing Catch-Up To Big Tech, May 14, 2019
  • The Future Of Banking: Fintech Flags Turning Point For Australian Banking, April 30, 2019
  • The Future Of Banking: Asia-Pacific Opens Up To Open Banking, April 11, 2019
  • Hong Kong's First Virtual Bank Licenses Will Rejuvenate The Banking Sector, March 29, 2019
  • Singapore Banks Must Adapt To Fintech Or Lose Out, Feb. 20, 2019
  • Slower Growth To Support Major Korean Commercial Banks' Capitalization, Feb. 20, 2019

This report does not constitute a rating action.

Primary Credit Analyst:Daehyun Kim, CFA, Hong Kong (852) 2533-3508 ;
daehyun.kim@spglobal.com
Secondary Contacts:HongTaik Chung, CFA, Hong Kong (852) 2533 3597;
hongtaik.chung@spglobal.com
Scott Han, CFA, Hong Kong (852) 2532-8022;
Scott.Han@spglobal.com
Emily Yi, Hong Kong (852) 2532-8091;
emily.yi@spglobal.com
Martin Kim, Hong Kong + 852 2533 3570;
martin.kim@spglobal.com

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