The Bank of Korea to Give Big Cut 1 Trillion KRW from 5 Major Banks' Net Profit...Profitability 'Red Light' (Comprehensive)

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[Asia Economy Reporter Kangwook Cho] The unprecedented era of zero interest rates has triggered red alerts for profitability management in the banking sector. As the net interest margin (NIM), a core profitability indicator of commercial banks, deteriorates, each bank faces the risk of losing billions of won in net income this year. With the prolonged COVID-19 pandemic raising concerns about a potential 'domino collapse' of financially vulnerable marginal companies and low-income households, worries about the deterioration of asset quality in the banking sector are intensifying. The real economy's shock is spreading to the financial sector.

According to the financial sector on the 17th, it is forecasted that the total net income of the five major domestic commercial banks?Shinhan, KB Kookmin, Hana, Woori, and NH Nonghyup?will decrease by as much as 1 trillion won this year. Typically, when the base interest rate is lowered by 0.25%, an individual bank's annual net income decreases by 100 billion won. In other words, with the recent 0.5 percentage point cut, an annual net income reduction of 200 billion won per large commercial bank has become inevitable.

Following two base rate cuts last year, the low interest rate trend has continued, steadily lowering the NIM of domestic banks. According to the Financial Supervisory Service, the overall NIM of the domestic banking sector slightly rose from 1.63% at the end of 2017 to 1.67% at the end of 2018 but dropped sharply by 11 basis points to 1.56% at the end of last year. By bank, as of the end of last year, Shinhan Bank and Hana Bank saw a 15 basis point decrease compared to a year earlier, Woori Bank dropped 14 basis points, and Kookmin Bank fell 9 basis points. Due to the COVID-19 crisis and the rate cuts, the NIM decline in the first quarter of this year is expected to widen further by 3 to 4 basis points or more. Shinhan Investment Corp. projects the banking sector's annual NIM to decrease by about 7 basis points and pre-tax profits to fall by 5.5%.

The era of '0%' fixed deposits is also approaching. Most fixed deposit interest rates are already stuck in the 1% range. According to the Bank of Korea, as of the end of January, 98.7% of fixed deposits at deposit banks had interest rates below 2%. Particularly, for fixed deposits under six months based on new contracts, the deposit interest rate recorded an all-time low of 1.38%. For savings banks, which offer relatively higher interest rates, there is a forecast that the 1.5% level could be breached due to the recent base rate cut.

The problem is that there are no suitable cards to prevent such profitability deterioration. The government's ultra-strong loan regulations have put brakes on loan growth for banks, and non-interest income has also been hit due to issues like overseas interest rate-linked derivative-linked funds (DLF) and the Lime Asset Management scandal. In fact, the average loan growth rate of banks is analyzed to shrink from 7-8% until last year to the 4% range over the next three years from this year to 2022. Moreover, due to the COVID-19 crisis, investment and employment by large corporations are shrinking, further dampening loan demand.

Meanwhile, concerns about the worsening of non-performing loans are growing as the risk of mass bankruptcies among self-employed individuals and small and medium-sized enterprises (SMEs) increases. It is estimated that the loan volume for self-employed borrowers, who are most sensitive to economic cooling, has already surpassed 700 trillion won, raising concerns that this could become a 'time bomb' for the Korean economy. Defaults are rapidly increasing, especially among frontline self-employed workers in sectors hit hard by COVID-19 such as food service, lodging, and retail, which could lead to loan delinquencies in financial institutions. According to the Financial Supervisory Service, the delinquency rate on won-denominated loans (based on principal and interest overdue for more than one month) at domestic banks was 0.41% at the end of January, up 0.04 percentage points from the end of the previous month. Considering that domestic economic concerns intensified in February, the delinquency rate is likely to worsen going forward.

Accordingly, banks are expected to increase loan loss provisions in preparation for potential loan defaults. Hana Financial Investment estimates that the loan loss provisions for Shinhan, KB, Hana, and Woori Financial Group will reach 3.658 trillion won this year, a 50.8% increase compared to the three-year average of 2.4437 trillion won.

Banks have entered an emergency management system. The 'big cut' in the base interest rate is evidence of worsening economic conditions, prompting banks to assume the worst-case scenarios and seek future response measures.

A senior official at a commercial bank said, "We are conducting stress tests by setting worst-case scenarios and examining the impact on bank profits. The problem is that concerns about future defaults outweigh profits, and currently, it is impossible to gauge how far corporate and self-employed loan defaults will spread and the shock they will cause."

This content was produced with the assistance of AI translation services.