Industry Trend Analysis - Online Banks To Be A Catalyst For Fintech Disruption - OCT 2017

BMI View: T he provision of a banking licenc e to Kakao Bank marks a further step in the development of the finte c h industry in South Korea and is likely to see banks push for greater deregulation amid a difficult operating environment as the rise in online banking poses a threat to conventional banks. We believ e that the provision of a licenc e will be positive for the development of more digital services and e-commerce, providing new avenues of growth in the financial sector.

South Korea's Financial Services Commission (FSC) has granted Kakao Bank a banking licence, allowing it to become the country's second online-only bank. This is likely to trigger fierce competition between rival K bank which started operations in early April 2017 and existing conventional banks and we view this as a further broadly positive step in the development of South Korea's fintech industry. The increased presence of online banks poses a potential threat to traditional banks. As the latter are already struggling with a difficult operating environment stemming from a highly competitive industry, high levels of household debt, and existing government regulations, we believe that greater competition from non-banking financial institutions is likely to prompt banks to push for greater deregulation. In turn, this will be positive for the development of more digital services and e-commerce, providing an alternative avenue of growth for the banking sector.

Conventional Banks Becoming Increasingly Squeezed

Despite the improvement in Q117 bank earnings, conventional banks in South Korea continue to face a challenging operating environment and the development of the fintech sector is likely to be viewed as a threat to the banking sector. The Korean banking industry continues to struggle with low margins and smaller banks have been struggling to establish dominance in a fragmented domestic market. Narrowing profit margins continue to weigh on profitability, with the average net interest margin reaching all time lows of 1.54 in Q316. Bank lending is likely to remain constrained by high levels of household debt (approximately 90% of GDP), with the Moon Jae-in administration having stated that it is seeking to work with the central bank 'on interest rates and try to improve the quality of household debt by restricting bank lending'. Slower growth in 2017 (we forecast real GDP to grow by 2.6% compared to 2.8% in 2016) will also continue to weigh on the banks' operating outlook, informing our forecast for loan growth to expand by 6.5% y-o-y in 2017 compared to 7.4% in 2016. Lastly, banks remain constrained by government regulations that hinder conventional banks' investment in the fintech space.

Still Razor-Thin
South Korea - Net Interest Margins, %
Source: BMI, Bloomberg

Pressures Could See Increased Lobbying For Financial Deregulation

As such, we believe that the increased competition could see banks start to lobby the government for greater deregulation to enable them to better compete against non-financial institutions in the fintech sphere. Indeed, we are seeing signs of this with the Korea Federation of Banks having called for the Moon administration to steer clear of regulations that it said have deterred local banks from dealing with the environment shift in financial circles. The banking federation also suggested the Moon administration publicise fingerprints and ease regulation on servers for cloud computing and blockchain technology, based on which the federation said the banks would be able to pursue innovation. While the government has stated its support for developing innovation as part of the Fourth Industrial Revolution (Industry 4.0), we believe that efforts are likely to be limited for the time being as it focuses on job creation. In addition, a cautious central bank will likely seek to ensure that deregulation is carried out at a slower pace than the conventional banks are seeking.

An A ccelerator Of Digital Services A nd E-commerce

On the other hand, the presence of two online-only banks will act as an accelerator of e-commerce and digital services, providing new avenues of growth. We estimate South Korea's e-commerce market value to reach USD49.7bn in 2020, up from USD37.4bn in 2017. We believe the competition between K Bank and Kakao Bank will provide further stimulus to refine and improve digital banking services and tighten the link between banks and retailers.

South Korea's advanced ICT ecosystem and high smartphone penetration, which we estimate at over 78.2% in Q416, provide fertile ground for rapid take-up of fintech services. Following its launch on April 3 2017, K Bank signed up 60,000 customers within two days, demonstrating the strong appetite for such services. Both KT Corporation and Kakao have experience with consumer-driven services and have formed partnerships with various content providers. Access to Alibaba-powered marketplaces through Ant Financial's investments in both companies, will provide a further boost to e-commerce.

Kakao Leverages Chat App Userbase And Data
Kakao Talk - Monthly Active Users ('000)
Source: Kakao

Competition between both players will be fierce and will push both parties to refine their services, boding well for the retail sector. Much like K Bank, Kakao will allow customers to open bank accounts on their smartphones and offer banking services such as loan applications as well as the option to withdraw cash from ATMs. The quality and the portfolio of services will be key for both companies' success. We expect Kakao's service take-up to be at least as strong as K Bank's, as it leverages a strong customer base, experience in digital financial services and a diversity of consumer services.

Its chat app, Kakao Talk, has a userbase of over 42.4mn, which it will seek to leverage. The company's experience with its payments service Kakao Pay provides Kakao Bank with another advantage over K Bank. Launched in September 2014, the services had over 14mn subscribers in Q416 linking their credit or debit cards to the app. The diversity of the brand's services, which span from chat to gaming and ride-hailing services, will also be a strong selling point for take-up as its improves quality of services. This also gives Kakao access to a large amount of data on its customers across these services, which it can put to use to refine its services. Data on Kakao Taxi users could, for example, help Kakao determine the credit scores of potential customers for banking services.