In Korea, the rapid adoption of technology among consumers and social distancing measures following the COVID-19 outbreak will speed up banks' digital transformation. S&P Global Ratings expects Korean banks to continue strengthening their digital product and service offerings amid consumer demand for convenient banking services. The country's advanced IT infrastructure and deep smartphone penetration, as well as banks' technology investments enable these players to stay ahead of technology trends.

Financial regulators will continue to foster innovation. Initiatives such as a regulatory sandbox and open banking will intensify competition among banks, while spurring more innovative financial services. That said, we believe the stability of the banking system remains a priority. Financial regulators are cautious in issuing new internet-only bank licenses, implementing a stringent review process. There is a 34% ownership limit on internet-only banks by tech companies to prevent potential conflicts of interest and to limit their influence on the banking sector.

Incumbent banks will likely retain a large share of loans and deposits in Korea's banking system. Long-standing customer relationships and extensive branch networks are high operational barriers for new entrants. We expect incumbents to maintain their offline channels, with some restructuring or consolidating branches to gain operating efficiencies. Banks' ability to provide in-person customer advice or review customers' profiles, especially for corporate or mortgage loans, underpins their competitive advantage over internet-only banks. Two internet-only banks--KakaoBank Corp. and K bank--have a small presence focusing on unsecured retail loans.

In our view, potential business disruptions from fintech companies will also likely be limited. Banks offer various transaction services without fees for major customers, and transaction-related fees are not a major revenue source. We also attribute this to the country's high usage of credit card payments. However, an increase in fintech services that compare banking products to offer tailored products to customers will intensify competition among banks. This could strain banks' profitability, which is relatively low on an international comparison.

TRIP Analysis For The Korea Banking Industry

We are illustrating our current views of disruption risk with our four-factor analysis of the Korean banking system's technology, regulation, industry, and preferences (TRIP; see chart 1) relative to international peers'.

Chart 1

Technology: Disruption Risk Low (2)

We expect incumbent banks to sustain their competitiveness even as the sector becomes more digital. In our opinion, Korean banks are fast to adopt new technologies such as cloud, artificial intelligence (AI), blockchain, and open banking. Banks are also investing in and cooperating with fintech companies to stay ahead of technology trends.

We assess overall tech disruption risk from technology as low for Korean banks. This is similar to other markets such as Hong Kong and Singapore, where banks benefit from well-equipped infrastructure and rapidly move toward digital transformation. We view the disruption risk as lower than Taiwan's or Japan's, where banks' implementation of new technology is relatively slow in part due to management plans or investment resources.

Korean banks are committed to investing and improving their internal systems. The banks are revamping their IT systems to accommodate bigger data processes and strengthen stability and security. Most of the banks have embarked on adopting cloud-driven IT systems. In particular, major financial holding companies with bank subsidiaries are establishing groupwide cloud systems across bank and nonbank businesses.

We expect to see increasing use of AI to enhance banks' operating efficiency and improve customer service. Various uses of AI among the banks include data processing, providing customer advice, human resources management, or fund transfers. For example, the largest bank, Kookmin Bank, has applied robotic process automation to various back-office operations, significantly reducing working hours. We also believe Korean banks will continue adopting blockchain technology in their operations. Some major banks are working to roll out blockchain-based platforms, enhancing global payment and fund transfers, and derivative transactions.

We believe that the country's advanced IT infrastructure, such as well-distributed and high-speed internet networks, supports banks' digital transformation. Smartphones have also rapidly become popular since the 2010s, boosting the growth of mobile banking services. Korea's smartphone penetration rate is one of the highest in the world.

Chart 2

The incumbent banks have a long history of offering comprehensive banking services through their internet and mobile banking platforms. Korean banks had a total of 149 million retail accounts registered for the use of internet banking (including mobile banking) as of the end of December 2019, indicating an average of about three accounts per citizen (see chart 3).

The growth of internet and mobile banking will continue as banks strengthen their product and service offerings through digital platforms. The trend of sales through digital and mobile channels amid social distancing due to the COVID-19 outbreak will also expedite banks' digital transformation.

About 60% of simple banking services, such as deposits, withdrawals, and money transfers, were processed via internet and mobile banking in 2019, steadily increasing from about 40% in 2015. Just about 8% of the services were made at bank branches or offices in person. Automated teller machines (26.4%) and telebanking (6.3%) accounted for the remainder in 2019.

Chart 3

Chart 4

The full-scale implementation of open-banking services since Dec. 18, 2019, with participation from all domestic banks and qualified fintech companies, allow customers to access multiple accounts across different banks on a single platform. This is compared with other major Asia-Pacific countries where the implementation has been delayed or will phase in. Nonbank depository institutions such as credit cooperatives and mutual savings banks also plan to join the open-banking platform by end-2020.

Korea's open-banking system is centrally governed and operated by the Korea Financial Telecommunications and Clearings Institute (KFTC), which ensures stability and security of the system. This is similar to the U.K. model, where third-party service providers need to be approved by a centralized agency, the Financial Conduct Authority. We view this centralized approach effectively facilitates the expansion of the digital ecosystem through more collaboration among various participants. This is different from Hong Kong, where banks negotiate with each third-party service provider bilaterally.

We believe Korea's open-banking system is advanced in that it provides not only financial information aggregation, but also allows wire transfer transactions. The U.K. is also advanced in open banking but many other countries' open banking currently stop short at the former.

Chart 5

Greater transparency of customer financial profiles under open banking will enable banks to offer tailored-products to suit customers' needs. Innovative services from third-party fintech companies using data from banks will not only benefit customers but also help banks to find and acquire new customers. That said, aggregation of data will also increase price transparency, which will intensify competition among banks. We also expect potential data-security risk to remain and the related costs to increase due to sharing of customer data with third parties.

We believe individual banks will continue to improve their products and services by collaborating with fintech companies. Nationwide commercial banks, such as Kookmin Bank, Shinhan Bank, Woori Bank, and KEB Hana Bank, have established fintech labs as early as 2015-2016. The labs enable them to fund fintech startups, explore technology that can enhance their product offerings, or facilitate back-end operations. This could increase investment costs in the short term, but produce cost-saving or revenue-generating opportunities in the longer run. Major banks have already built their own open API platforms to provide more comprehensive financial services to customers together with fintech companies, including payments, remittances, peer-to-peer lending, and asset management, although the business scale is small at this stage.

Regulation: Disruption Risk Moderate (3)

We believe the stability of the banking system will remain a priority even if the financial regulators promote innovation by easing some regulations. The financial regulators will likely stay cautious in issuing new licenses for internet-only banks. There is a cap for nonfinancial companies to own stakes in internet-only banks, albeit with some relaxation. This is to avoid potential conflicts of interest between banks and nonfinancial companies and nonfinancial companies' influence on the banking sector.

We believe the financial regulators are supportive of Korean banks' digital transformation by facilitating their strategic investments in fintech companies. Financial regulatory sandbox and MyData business will foster innovation, but also intensify competition among banks due to customers' easier access to financial data and increased pricing transparency of banking products.

Tech disruption risk from regulation appears moderate. We expect the financial regulators to strike a balance between innovation and system stability. We view this as similar to Singapore but the risk is lower than Hong Kong or the U.K. This considers the financial regulators' more cautious approach in allowing new entrants. For example, Hong Kong Monetary Authority approved a total of eight virtual bank licenses in May 2019, although their presence remains fairly small. In Korea, only two internet-only banks are operating, and one more preliminary approval was granted in December 2019. That said, we view the risk is higher than in China. Given the large scale of business by fintech companies, China's regulators are closely monitoring fintech operations to prevent potential failures in the banking system.

Table 1

(i) Internet-only banks: High entry barriers despite eased regulations

We believe that ownership rules for banks remain stringent despite some easing for internet-only banks since January 2019. Nonfinancial companies focusing on information and communication technology (ICT) business can own stakes of up to 34% in internet-only banks. Although this is much higher than ownership limits for domestic incumbent banks, it is stringent compared with other countries such as Hong Kong, the U.K., or Germany, where there is no ownership limit for tech companies. Under Korea's banking law, nonfinancial companies are prohibited from owning more than 4% voting rights in a nationwide commercial bank (15% for regional bank), while owning stakes of up to 10% are permitted upon approval from the Financial Services Commission (FSC).

Although the FSC is willing to allow more new internet-only banks to enter the market, the regulatory barriers are high, in our view. Various factors such as business innovation and stability, eligibility of the largest shareholder, and funding capability are assessed for a new entrant. The FSC rejected two new applicants for internet-only banking licenses in May 2019 due to lack of business innovation and feasibility or funding capability and only granted a preliminary license to Toss Bank in December 2019.

(ii) Eased regulations on financial companies' investments in fintech companies

The financial regulators encourage financial services companies including banks to strengthen their digital competitiveness via strategic investments in fintech companies. Banks can get an accelerated regulatory approval (i.e., within 30 days) to make strategic investments in, and operate an expanded scope of fintech business such as innovative technology or financial services recognized by the FSC as an ancillary business. This is based on a two-year trial of regulatory easing that began in October 2019. Previously, an ancillary business was only limited to ones directly related to banks' primary business.

(iii) However, financial regulatory sandbox to intensify competition

The regulatory sandbox has allowed developers to experiment with new financial products and services with an exemption from some regulations during a trial period of up to four years. This approach will enable prompt testing and eventual commercialization of new financial services in the market. We believe competition would intensify among banks. Some fintech companies, for example, provide smartphone-based loan application services searching for optimal pricing and tailored loan products based on customer information across multiple financial institutions.

Banks, however, could also benefit from the regulatory sandbox by introducing innovative banking services that improve convenience and attract more customers. Examples of this include Woori Bank's foreign exchange and withdrawal services at drive-through restaurants and car parks near airports, NongHyup Bank's mobile appointment-scheduling service using AI, or Daegu Bank's personal authentication service using facial recognition technologies.

Since the launch of the regulatory sandbox in April 2019, the FSC approved a total of 106 services by June 2020 to allow various innovative services to be tested in the market.

(iv) MyData business will bring more innovation and competition

In our view, customers' easier access to, and control of, their own financial data, as well as increased pricing transparency and service quality among the banks under the MyData business, will bring more competition. The revision of the Credit Information Use and Protection Act on Jan. 9, 2020, provides a legal basis for the use of big data and introduction of MyData business in Korea. This will take effect on Aug. 5, 2020, and enable data sharing across different financial intermediaries such as banks, insurers, securities firms, card companies, and payment services. It will allow customers to receive tailored asset management services in a single platform.

We expect major banks under a financial holding company structure, which have diverse nonbank business operations, to create synergies from the MyData initiatives, leveraging off their better understanding of customers' financial conditions and life patterns.

Industry: Disruption Risk Moderate (3)

In our view, the incumbent banks' long-standing relationships with customers, extensive branch networks, and advanced digital platforms will present a high operational barrier for new entrants to compete in Korea's mature banking market.

Korean banks' profitability is relatively low on an international comparison, albeit some improvements in the past few years. While fintech companies may not be directly competing with banks, their innovative financial services could deepen competition among banks and put some pressure on profitability. Korean banks heavily rely on net interest income, which accounted for about 85% of total revenue over the past several years.

Overall, our moderate assessment is similar to that on China and the U.K., mainly reflecting our view that major Korean incumbent banks will continue to hold their own against potential tech disruption. The risk is higher than in Hong Kong, Singapore, and Australia considering Korean banks' relatively low profitability, making them more vulnerable to disruption risk. The risk is lower than in Taiwan, which we assessed to have high industry risk considering the highly fragmented competitive landscape resulting in more intense competition.

Chart 6

The competitive landscape in Korea remains largely unchanged even after the launch of open-banking services. The industry is dominated by four nationwide commercial banks and two policy banks: Kookmin Bank, Woori Bank, KEB Hana Bank, Shinhan Bank, NongHyup Bank, and Industrial Bank of Korea, among 19 domestic banks in the country. These banks collectively account for about 60% of market share in total loans and deposits of deposit-taking institutions as of March 2020 (see charts 7a and 7b). Six regional banks also have robust business presences in their respective regions.

Chart 7a

Chart 7b

We believe that internet-only banks will unlikely present significant disruption in the banking system over the next few years. The internet-only banks focus on the unsecured-retail loan segment, while nationwide commercial banks have a balanced loan structure across corporate and households. Given the internet-only banks' sole digital channel and short operating history, we believe there are some constraints for them to develop sophisticated underwriting processes and build up relationships with customers, especially for corporates and mortgage lending business. We estimate that unsecured-retail loans accounted for about 10% of the banks' total Korean won-denominated loans as of March 2020.

Korean banks will also likely continue to innovate. For example, major banks have introduced several retail-loan products that customers can access through their mobile phones with quicker approval process in response to similar product offerings by internet-only banks.

Chart 8

Korea's two internet-only banks--KakaoBank Corp. and K Bank--have a small presence thus far. They collectively comprise only about 0.5% of the loans in the system as of March 2020. The underwriting and risk management capabilities would be tested given their rapid growth since their launch in 2017.

We believe that nonfinancial companies' ownership limit and complex shareholding structures make it difficult for internet-only banks to grow their capital bases in a timely manner. For example, K Bank's business growth has stalled in 2019 due to capital constraints. KT Corp., which planned to become the largest shareholder of K Bank, did not meet the eligibility major shareholder requirements, which caused a delay in additional capital injection to K Bank. BC Card Co. Ltd., a subsidiary of KT Corp., instead will inject capital (total KRW400 billion) together with other major strategic financial institutions investors, and become the largest shareholder of K Bank with a 34% stake following regulatory approval on July 22, 2020.

The growth of internet-only banks, however, could increase competition over the medium to long-term as they scale up and more new internet-only banks enter. They will exert some pressure on incumbent banks' net interest margins. Given their low overhead costs, internet-only banks offer relatively competitive deposit rates for customers, propelling high business growth so far. In particular, KakaoBank started to make some net profits since 2019, while K bank is still making net losses.

In our view, fintech companies do not pose a material risk to the banking sector. The incumbent banks already offer various transaction services without fees for major customers through their internet and mobile banking platform. This is in part due to high competition among banks, which has led to reduced fees across the industry.

Major fintech companies, such as KakaoPay, Naver Financial, Viva Republica (which offers its services through Toss) have made the biggest inroads into small-amount payment or money transfers. Meanwhile, the presence of global tech companies is fairly small in Korea. Kakao has the country's most popular mobile chat platform and Naver dominates the web portal segment in Korea. The major fintech companies gained popularity especially among the younger generation, who can easily make payment or transfer money using their mobile-phones.

Table 2

Peer-to-peer lending is very small in Korea with the outstanding loan balance at only about KRW2.4 trillion as of March 2020. The financial regulators are strengthening their oversight on this segment due to some illegal sales activities identified and increase in delinquency in recent years.

In addition, we anticipate fintech companies to have low potential to disrupt the payment system, given Korea's high credit card penetration by retail customers. We attribute this partly to some deduction in taxable income on card spending relative to their income as well as card companies' aggressive marketing with various benefits to customers. Credit card transaction amounts accounted for about 70% of private consumption expenditure in 2019, which have steadily increased over the past several years. About four credit cards are issued per economically active person in Korea.

The high card penetration is similar to Hong Kong's. In contrast, for countries such as China, the low usage of credit cards triggered significant growth in payment services offered by fintech companies.

Chart 9

Preference: Disruption Risk Moderate (3)

We view that Korean banks are able to cater for tech-savvy customers' demands for fast and convenient banking services. The banks are continuously improving their product and service offerings through digital platforms, which enable them to keep their main customers.

Customers' trust based on long-standing relationship and the rapidly aging population also moderate some risk from tech disruption, in our opinion. Overall, we assess tech disruption risk from customers preference as moderate.

We see higher risks than in Hong Kong and Singapore considering Korean customers' high interest in using open banking or registration of internet-only bank accounts. In our view, the risk is lower compared with Australia or the U.K. considering the country's rapidly aging population with the lowest fertility rate.

Korean customers are fast to embrace new banking services. The number of users for open-banking services increased rapidly since its official launch in December 2019. As of end-June 2020, about 20 million customers have registered for open banking services, which is about 40% of the country's population. While customers mainly check their account balances or transaction history using open banking services, the use of money transfer services offered by fintech companies have been growing fast.

KakaoBank also quickly attracted new customers, leveraging the Kakao brand name and its famous mobile chat application. The bank's registered customers were about 12 million, about 24% of Korea's population, as of end-March 2020.

That said, we believe the accounts at internet-only banks will likely be supplementary rather than completely replacing the customers' existing banking relationship.

We expect the incumbent banks to maintain offline and digital channels to cater for different customers' needs, despite some restructuring and consolidation of their branch offices to enhance efficiency. In addition, we believe open-banking services increase the overall use of banking services such as checking account information or money transfers through the digital platform rather than significantly changing banks' competitive landscape.

Chart 10

We also anticipate that Korea's rapidly aging population will slow any significant shift from incumbent banks to internet-only banks. This is similar to other developed markets such as Japan, Hong Kong, and Germany. The elderly population has less propensity or willingness to use mobile banking or services provided by fintech companies compared with the younger generation. These customers in general have larger savings and will likely stick to traditional banking services offered by incumbent banks. The country's fertility rate is also slightly below one in 2019, which is the lowest in the world.

Chart 11

Chart 12

Chart 13

Korean Banks Hold Their Ground Against Tech Disruption

Social distancing measures due to the COVID-19 pandemic will accelerate banks' digital transformation. Korean banks appear well-positioned to manage disruption risk from technological developments by strengthening their operational efficiency as well as product and service quality.

However, we believe an increase in profitability pressure--due to higher credit losses arising from pandemic-led economic headwinds, prolonged low interest rates, and intensifying competition among banks--can present challenges for the banks' digital transformation.

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