[Financial Essay] Banks' Profitability on a Downward Path... What Is the Survival Strategy?

The Era of Earning Money from Loan-Deposit Margin Ends
Big Tech's Financial Sector Invasion 'Helpless'
Banks Must Hurry Digital Transformation to Survive

[Asia Economy Reporter Kim Min-young] In the second half of the year, the soundness of domestic banks is expected to deteriorate and profitability to worsen, indicating that the management environment for banks will remain challenging due to the prolonged COVID-19 pandemic. There are concerns that this could negatively impact the supply of funds to the real economy.

In the report titled "2020 Second Half Banking Management Environment Outlook and Key Management Tasks" released on the 21st, Senior Research Fellow Seo Jeong-ho of the Korea Institute of Finance forecasted that, following the first half of this year, the economic downturn and low interest rate trend will continue in the second half, making it practically difficult to expect an improvement in the profitability of domestic banks, and the expansion of loan assets will also be limited.

As of the end of April, the loan-deposit margin (the difference between deposit and loan interest rates) was 1.60%, marking the lowest monthly level since December 2008 (1.31%) during the global financial crisis. When banks’ loan-deposit margins, which generate profits from the difference between deposit and loan interest rates, shrink, profitability rapidly deteriorates. The net interest margin (NIM), which is the interest income minus funding costs, was also at a record low of 1.46% in the first quarter.

Senior Research Fellow Seo said, "Since March this year, corporate loans have increased sharply as companies focused on securing liquidity, but unless there is a dramatic economic rebound in the second half, ordinary loan demand is expected to shrink." He added, "Accordingly, the scale of banks’ interest income is likely to stagnate or shrink compared to the first half."

Furthermore, due to the COVID-19 crisis, a downward revision of macroeconomic indicators such as economic growth rates, corporate credit rating downgrades, and an increase in expected losses on existing loans are expected to create a vicious cycle, leading to an increase in banks’ loan loss provisions. Loan loss provisions are accounting entries that financial companies treat as expenses in anticipation of not recovering part of the loans they have extended. While accumulating more provisions improves soundness, it worsens profitability.

Additionally, with the full-scale introduction of the MyData industry (personal credit information management) in August, the expansion of open banking, and the advancement of big tech companies, market competition in the banking industry is expected to become more intense. Senior Research Fellow Seo stated, "Large platform operators such as Naver and Kakao, as well as telecommunications companies, are expanding their competitiveness in selling financial products based on simple payment and remittance functions." This means that banks, which were protected as licensed industries, are now exposed to unlimited competition due to digital innovation and the emergence of new competitors in the changed financial environment.

In this environment, Senior Research Fellow Seo suggested that domestic banks should focus on their primary role as financial intermediaries while accelerating digital transformation in the second half of this year. He said, "Banks should quickly move away from loan practices that emphasize collateral and evaluate borrowers’ competitiveness from a mid- to long-term perspective, actively supplying funds to borrowers who are temporarily judged to be facing liquidity shortages." However, he advised, "As the COVID-19 crisis prolongs, measures such as issuing subordinated bonds for capital expansion, increasing internal reserves, managing profitability, and strengthening monitoring of vulnerable sectors should be promptly implemented to prevent the crisis from evolving into a complex real and financial crisis." He also viewed this as the time to strengthen digital transformation to improve cost structures and explore opportunities for mergers and acquisitions (M&A) with financial companies or fintech firms.

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