Authorities Maintain Accumulation Policy... Financial Firms Must Build More Provisions This Year

Preparing for Potential Deterioration in Soundness
"Loss Absorption Capacity Uncertain Due to Illusion from COVID-19 Support Measures," Critics Point Out

[Asia Economy Reporter Song Hwajeong] Financial companies that have been building reserves to prepare for financial shocks after COVID-19 are expected to remain burdened by reserves this year as well. This is because financial authorities plan to continue the policy of reserve accumulation by financial companies to prepare for the possibility of deteriorating asset quality due to the prolonged COVID-19 pandemic.

According to the financial sector on the 15th, the Financial Supervisory Service (FSS) announced in its business plan released the previous day that it will encourage financial companies to accumulate sufficient reserves in preparation for the possibility of asset quality deterioration due to the prolonged COVID-19 pandemic and the end of repayment deferrals for vulnerable borrowers. The FSS plans to inspect differences in asset quality classification among banks for vulnerable borrowers if necessary, and particularly induce capital expansion, additional loan loss reserve accumulation, and strengthened risk management in vulnerable sectors for financial companies with weak asset quality or concerns about insolvency.

Earlier, at the 'Macroeconomic Financial Meeting' held on the 11th, the authorities also decided to check the performance of loan loss reserve accumulation and encourage sufficient accumulation to enhance the financial sector's loss absorption capacity.

Last year, financial holding companies' reserves decreased compared to the previous year. This is because they had proactively accumulated sufficient reserves in 2020 and judged that there were no problems with asset quality as delinquency rates also decreased last year. The total loan loss reserves of the four major financial holding companies?KB, Shinhan, Hana, and Woori Financial?last year amounted to 3.1765 trillion won, down 20.4% from the previous year. Hana Financial's loan loss reserves last year were 521.3 billion won, a 38.5% decrease from the previous year, and Woori Financial's were 537 billion won, down 31.5%. Shinhan Financial's reserves were 996.4 billion won, a 28.3% decrease from the previous year, meaning that three out of the four, excluding KB, reduced their reserves.

There are concerns that the loss absorption capacity of banks cannot be accurately assessed due to an optical illusion caused by COVID-19 financial support measures. Lee Sunho, a research fellow at the Korea Institute of Finance, analyzed, "The loan loss reserve ratio of domestic banks has steadily increased from 110.6% at the end of March 2020, when COVID-19 broke out, to 156.7% at the end of September 2021. Support policies such as loan maturity extensions and principal and interest payment deferrals for small business owners and SMEs may have delayed the realization of defaults, thereby maintaining good asset quality, which is estimated to have resulted in a high loan loss reserve ratio for domestic banks." He added, "Given the low likelihood of significant improvement in the business environment for small self-employed and small business owners due to the Omicron variant, the loan loss reserve ratio calculated based on currently realized non-performing loans is not only an insufficient indicator of banks' loss absorption capacity but may also mislead."

As the financial authorities' policy of reserve accumulation is expected to continue, it is anticipated to act as a variable affecting the performance of financial holding companies this year. Seo Youngsoo, a researcher at Kiwoom Securities, said, "The level of reserve accumulation by domestic banks is relatively low compared to other advanced countries due to a low proportion of principal and interest repayments and repayment deferrals. Therefore, there is an inherent possibility of a sharp increase in loan loss reserves in a short period if interest rates rise, loan limits are reduced, repayment deferrals end, or the proportion of principal and interest repayments increases." He added, "The level of additional reserve accumulation will be an important variable for bank performance."

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