The Boom from Rapid Interest Rate Hikes Ends... Bank Competition to Intensify Further Next Year

Pressure to Lower Loan-Deposit Interest Rate Spread and Rising Funding Costs Increase Burden
NIM Growth Slows Inevitably... "Low-Cost Funding Defense is Key"

[Asia Economy Reporter Minwoo Lee] As the base interest rate rises sharply, banks are posting record-breaking profits. However, there are forecasts that various side effects caused by the rapid increase in interest rates will emerge, meaning it will not always act as a positive factor. It is analyzed that the ability to defend low-cost deposits will become crucial as the funding environment deteriorates.

On the 13th, Jungwook Choi, a researcher at Hana Securities, made this assessment. He analyzed that due to issues such as construction project financing (PF) problems caused by real estate contraction and rising delinquency rates on household credit loans, side effects rather than benefits from the rapid interest rate hike will surface. Typically, during periods of rising interest rates, banks' net interest margin (NIM) improves because the increase in base rates is reflected more quickly in loans than in deposits. This is the background for domestic banks achieving record profits.

However, Choi predicted that the period when rising interest rates act as a 'positive factor' for banks will not last long. He explained, "The average bank NIM is expected to rise by 20 basis points (bp; 1bp=0.01%) this year, but next year it will increase by only 9bp," adding, "As the base interest rate has risen more sharply than expected, pressure to reduce the loan-deposit interest rate spread and the burden of rising funding costs are increasing."

He particularly pointed out that the side effect of the rapid interest rate hike is an inevitable rise in the 'credit cost' (the ratio of loan loss provisions to loan balances). While loan loss costs generally increase with a lag after interest rate hikes, they have been declining due to the extension of COVID-19 financial support. Although a significant deterioration in asset quality is unlikely, the loan loss cost ratio to total assets is expected to rise from 0.21% this year to 0.24% next year.

As vulnerabilities to rising interest rates are exposed, latent risks such as real estate PF loans are expected to begin materializing. The funding environment is also worsening, inevitably leading to a contraction in NIM. With market interest rates soaring, low-cost deposits such as demand deposits and savings deposits are rapidly decreasing, while time deposits are surging. According to the Bank of Korea, low-cost deposits at deposit banks decreased by KRW 44.2 trillion compared to the previous month last month. Meanwhile, time deposits increased by KRW 56.2 trillion during the same period, the largest scale since related totals were compiled in 2002. To stabilize the bond market, bank bond issuance is being restrained. Significant changes in banks' funding methods are inevitable.

Pressure from authorities is also intensifying. Choi said, "So far, pressure to lower interest rates has been limited to household loans related to mortgage loans, but it is not possible to rule out the possibility that such pressure will extend to corporate loans in the future," adding, "In addition, concerns about various financial regulations and support measures to stabilize the market are emerging." He continued, "Considering the pressure to reduce the loan-deposit interest rate spread and the impact of rising funding costs, quarterly NIM could turn downward in the first half of next year," but noted, "However, if the possibility of continued base rate hikes increases, the timing of the NIM decline could be delayed."

As the funding environment worsens like this, the ability to defend low-cost deposits and funding capacity are expected to emerge as key competitive strengths for banks. Choi analyzed, "Monthly active users (MAU) of mobile applications, corporate customer loyalty, and the ability to attract primary and secondary treasury deposits will determine the defense of low-cost deposits."

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