Bank of Korea: "Intensified Deposit Competition May Undermine Revenue Stability of Banks and Non-Banks"

"Importance of Financial Authorities' Efforts to Recommend Restraint in Deposit Competition"

The Bank of Korea pointed out that the more intense the deposit competition, the lower the earnings stability of deposit-taking institutions. In particular, when competition for bank deposits is triggered, its ripple effects quickly spread to the non-bank sector, which lacks alternative funding sources other than deposits. Therefore, there is a policy need to more closely monitor liquidity management situations such as the maturity and re-deposit scale of bank deposits during normal times.

On the 11th, the Bank of Korea stated in its recent report, "BOK Issue Note: Changes in Deposit Procurement Behavior of Deposit-Taking Institutions and Policy Implications," that "As the deposit interest rate spread widens, the volatility of the return on total assets of deposit-taking institutions increases, resulting in decreased earnings stability."

According to the report, in the third quarter of last year, the deposit interest rate spread in the banking sector reached 83 basis points (bp) (1bp=0.01%), the highest since 2014. Meanwhile, the non-bank sector responded by raising deposit interest rates, causing the deposit interest rate spread in the non-bank sector to widen significantly to 142bp in the fourth quarter of last year. The deposit interest rate spread refers to the difference between the weighted average deposit interest rate based on new deposits and the market-based deposit interest rate, and it is used to measure the level of deposit competition among individual deposit-taking institutions in the deposit market. During the period from the first quarter of 2014 to the second quarter of 2021, when there was no excessive deposit competition, the average deposit interest rate spread was 6bp for banks and 52bp for non-banks.

Deposit interest rate spread by industry. Source=Bank of Korea

The narrowing of the loan-deposit interest rate margin due to the rapid increase in deposit interest rates caused by deposit competition was analyzed to have negative effects on all components of financial stability, including high volatility of return on total assets, low profitability, and capital ratios. The report pointed out, "Deposit competition among deposit-taking institutions can broaden depositors' choices and enhance interest rate benefits, but excessive short-term increases in deposit interest rates can lead to decreased deposit stability and increased loan interest rates."

Competition for deposits in the banking sector has recently eased somewhat due to regulatory authorities' calls for restraint. Jae-won Yoo, a manager of the Bank Risk Team at the Financial Stability Department of the Bank of Korea, explained, "Since the second half of last year, financial authorities have recommended and managed restraint in deposit competition, and I believe these efforts were very important. Otherwise, deposit interest rates would have risen further, negatively impacting financial stability even more."

Money Move to Non-Banks Intensifies During Interest Rate Rise... Need for Central Association Liquidity Support Measures

As of the end of the second quarter this year, deposit-taking institutions rely on deposits for 74.3% of their total funding. Among them, non-bank deposit-taking institutions rely on deposits for 86.4%, while commercial and regional banks rely on 68.4%, indicating a high level.

According to the report, before the interest rate rise period (third quarter of 2019 to second quarter of 2021), banks and non-banks increased deposits by an average quarterly amount of 88.9 trillion KRW and 44.2 trillion KRW, respectively. However, during the interest rate rise period (third quarter of 2021 to second quarter of 2023), both sectors increased deposits by about 65 trillion KRW compared to the same period the previous year. Manager Yoo explained, "This is interpreted as a result of depositors' strengthened pursuit of returns during the recent interest rate rise period, leading to deposits being attracted to the non-bank sector, which has higher interest rate competitiveness compared to banks."

This led to an increase in the proportion of deposits placed in non-banks. Before the recent interest rate rise period (first quarter of 2014 to second quarter of 2021), 54.4% of the total deposit increase of deposit-taking institutions was placed in commercial banks, and 33.4% in non-banks. However, since the third quarter of 2021, the money move phenomenon toward the non-bank sector has continued, with 46.6% of the increased deposits during this period placed in commercial banks and 45.2% in non-bank deposit-taking institutions. Especially in the first half of this year, 64.9% of the increased deposits in deposit-taking institutions flowed into non-banks such as mutual finance and mutual savings banks, which offer relatively higher interest rates.

The report suggested measures to ease deposit competition pressures, such as flexible operation of market-based deposit procurement regulations for banks, and timely liquidity support measures by the central association when individual member institutions in the mutual finance sector temporarily face liquidity difficulties.

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