"Card Companies Partially Offset Fee Rate Headwinds with Increased Transactions... The Real Issue Is Interest Rates"

Rising Procurement Interest Rates - Emerging New Risk of Asset Quality Deterioration

[Asia Economy Reporter Yu Je-hoon] Despite the adverse effect of the reduction in merchant commission rates, the card industry is expected to partially offset this impact thanks to the lifting of social distancing measures and cost-cutting efforts. However, concerns have also been raised that rising interest rates leading to higher funding costs and strengthened loan regulations are emerging as new risks.

According to the financial sector on the 2nd, Korea Ratings recently published a report titled "The Bright and Dark Sides of the Credit Card Industry," diagnosing that "risks such as increased funding costs due to the base interest rate hike and the possibility of rising bad debt expenses are emerging as major risk factors for the card industry."

According to Korea Ratings, with the new commission rate system applied from January 31, the merchant commission rate for the card industry in the first quarter was 1.36%, down 0.07 percentage points from the end of the previous year. However, the new card issuance fees of the seven major card companies (Shinhan, Samsung, KB Kookmin, Hyundai, Woori, Hana, Lotte) in the first quarter increased by 6.3% year-on-year to about 2.6 trillion KRW. The end of social distancing led to a 9.8% surge in payment performance, partially offsetting the impact of the reduction in merchant commission rates.

Korea Ratings forecasted that while the full effect of the merchant commission rate reduction will be reflected from the second quarter, the increase in new card issuance and cost-cutting efforts will partially offset this impact for the time being. With the consumer price index (CPI) reaching 4.8% in April, indicating continued inflation, there is a high possibility of increased payment performance, and the industry's ongoing cost-cutting efforts are also proving effective. In fact, the card cost ratio relative to payment performance has continued to decline from 1.48% last year to 1.43% in the first quarter.

The card industry's steady expansion of its portfolio into non-payment areas is also expected to positively affect profitability. Recently, the card industry has been expanding its portfolio by focusing on long-term card loans (card loans), automobile installment financing, and new technology finance.

The problem lies in the tightening stance of the authorities and the impact of rising interest rates. To manage household debt, financial authorities have included card loans in the calculation of the debt service ratio (DSR) at the borrower level starting this year, causing card loan lending?which had been a key driver of profitability?to decline. In the first quarter, card loan usage decreased by 14.6% year-on-year to about 11.6 trillion KRW, and the average balance fell by 0.3% to 33.6 trillion KRW.

The expansion of funding costs due to rising interest rates is also a cause for concern. The structure that benefited from falling funding rates under the low-interest-rate environment has collapsed. The average interest rate on card bonds issued in the first quarter was 3.54%, with a spread of 0.74% compared to the average interest rate of maturing bonds. This is nearly twice as high as the 0.39% spread in the fourth quarter of last year.

There are also forecasts that asset quality could deteriorate due to the impact of rising interest rates. Card companies have rapidly increased loan assets based on abundant liquidity to defend profitability, but recent interest rate hikes and reductions in household loan supply raise concerns that this strategy could backfire. Korea Ratings stated, "The main risk factors for card companies have been the continued reduction in merchant commission rates and the resulting decline in profitability, but these pressures appear to be easing compared to the past. However, amid a long period of low interest rates, loan asset volumes have increased, and with recent rapid interest rate hikes, interest expense burdens are expected to expand significantly, raising growing concerns about the deterioration of loan asset quality."

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