Outlook for Korea’s Banking System Remains Stable

Moody’s Investors Service says that the outlook on the Korean banking system remains stable, reflecting an expectation that economic growth will gradually gain momentum while systemic support remains strong.

These findings were released in the Moody’s Korea Banking System Outlook, which expresses the agency’s expectation of how bank creditworthiness will evolve in this system over the next 12-18 months. The report looks at the banking system in the five categories of operating environment; asset quality and capital; funding and liquidity; profitability and efficiency; and systemic support. Moody’s assesses funding and liquidity as improving, and the remaining categories as stable.

Economic growth in Korea has gradually gained momentum, and Moody’s expects real GDP to grow 3%-4% in 2014, up from 2% in 2012 and 3% in 2013, but slower than the 4%-5% growth that Korea experienced before the 2008-09 global financial crisis.

Net exports are growing, while domestic demand conditions are mixed, with high levels of household indebtedness continuing to weigh on private consumption even as property prices in the Seoul-area recover from several years of weakness.

While asset-quality pressures are likely to persist over the outlook horizon, Moody’s does not expect such pressures to intensify relative to 2013, when a large shipping company filed for bankruptcy protection.

High leverage and a reliance on the commercial-paper market, which recently contracted, will continue to hurt large corporate borrowers in problematic sectors. However, retail asset quality and loans to small and medium-sized enterprises will be stable.

The report found that Korean banks are adequately capitalised, with a Common Equity Tier 1 ratio of 11.2% and a total capital adequacy ratio of 14.5% at end-2013. Korean banks have reduced their dependence on wholesale funding, and foreign-currency liquidity will continue to improve, reflecting the country’s strengthened external position. Foreign-currency deposits are increasing, although foreign-currency loan-deposit ratios remain above 100%. At the same time, the banks are extending the maturities of their foreign-currency obligations, reducing their dependency on short-term borrowings.

Profitability will remain low in 2014, according to the report, though net interest margins could increase in 2015 as policy rates rise. Non-interest income will remain under pressure, partly due to pro-consumer regulations such as a new requirement for banks to bear the cost of loan origination rather than passing the cost onto borrowers.

In Moody’s view, Korea has a strong support system. None of its national and regional banks have been liquidated in the past two decades, even when the banking system faced significant stress after the Asian financial crisis in the late 1990s.

“Asset-quality pressures are likely to persist from borrowers in industries facing long-term challenges,” says Sophia Lee, a Moody’s vice-president and senior analyst.

“However, Korean banks’ historical dependence on wholesale funding for foreign currency has lessened, reflecting the country’s strengthened external position. Bank profitability is low in Korea but could improve somewhat in 2015 as policy rates rise,” adds Lee.

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