🚨 Banking Profitability Crisis
Today Korean Economic News for Beginners | 2025.08.22
0️⃣ Seeking Solutions Through Non-Interest Income Expansion Amid Net Interest Margin Decline
📌 Banks Face "Traditional Profit Model Limits" Under Double Pressure of Rate Cuts and Lending Regulations
💬 Major Korean commercial banks are facing a profitability crisis. Net Interest Margins (NIM) are falling due to base rate cuts and stricter household lending regulations, causing traditional interest margin profits to drop sharply. In Q2, Kookmin Bank, Shinhan Bank, and Woori Bank all saw NIM declines, while Hana Bank only managed a small increase. Banks are struggling with decreased demand deposits, making low-cost funding difficult and forcing them to rely on expensive funding sources like bank bonds. As a result, banks are seeking new growth drivers through expanding non-interest income including wealth management (WM), investment banking (IB), and fee-based services, along with strengthening corporate lending.
1️⃣ Easy Understanding
The basic way banks make money is being shaken up. Banks used to make profits through the 'interest rate spread' - taking deposits at low interest rates and lending at higher rates. But now this method is hitting its limits.
Let me explain how banks make money simply. Banks pay customers 1-2% interest on deposits and charge 3-5% interest on loans. This difference becomes the bank's profit. For example, if a bank takes 100 million won in deposits at 1% and lends it out at 4%, they make 3% profit, which is 3 million won.
But now this structure has problems. First, the Bank of Korea lowered the base interest rate, so loan rates also went down. Banks can earn less interest from loans. Second, the government strengthened lending regulations to reduce household debt. The amount banks can lend has decreased.
The bigger problem is that getting deposits has also become difficult. When base rates fell, people started looking for other investments like stocks or funds instead of low-interest bank deposits. Especially 'demand deposits' - accounts where you can freely deposit and withdraw money - have decreased significantly. These deposits paid almost no interest, so banks could use this money almost for free. But as this money flows out, banks must pay higher costs to get funding.
So banks are facing a double problem: 'earning less money while funding costs increase.' This is called 'Net Interest Margin (NIM) decline' in technical terms.
Banks are looking for two main solutions. First is expanding 'non-interest income.' Instead of only relying on interest spreads, they want to make money through asset management services, card fees, corporate consulting, and other methods. Second is increasing corporate loans instead of household loans. Corporate loans have fewer regulations and can provide more stable profits.
Basically, banks are trying to transform from simple 'money lending' businesses into comprehensive financial service companies.
2️⃣ Economic Terms
📕 Net Interest Margin (NIM)
Net Interest Margin is the ratio of net interest income (interest earned minus interest paid) divided by total earning assets.
- This is the most important indicator measuring a bank's core profitability.
- Higher NIM means the bank is making money more efficiently.
- Generally, around 2% is considered appropriate, and if it falls to the late 1% range, banks face management difficulties.
📕 Demand Deposits
Demand deposits are accounts where customers can freely deposit and withdraw money anytime, like savings accounts or checking accounts.
- These pay little or no interest, so banks can use this money at almost no cost.
- They increase during good economic times but decrease rapidly when interest rates rise or other investments become attractive.
- When demand deposits decrease, banks must get funding through more expensive time deposits or bank bonds.
📕 Non-Interest Income
Non-interest income is revenue from fees, asset management, investment banking, and card services rather than interest rate spreads.
- This provides income sources that don't depend on the difference between loan and deposit rates, making bank management more stable.
- This includes credit card fees, asset management fees, corporate M&A advisory fees, and foreign exchange trading profits.
- Advanced country banks often have non-interest income making up over 50% of total income.
📕 Interest Rate Spread
Interest rate spread is the difference between the interest rate banks charge on loans and the interest rate they pay on deposits.
- This is the traditional and most basic source of bank profits.
- Larger spreads increase bank profitability, but if too large, banks may face social criticism.
- This constantly changes based on interest rate environment, competition, and regulatory policies.
3️⃣ Principles and Economic Outlook
✅ Rate Cut Cycle and Banking Profitability Pressure
Let's analyze the specific impact of base rate declines on bank profit structures.
First, rate cuts directly reduce banks' interest income. When the Bank of Korea lowers the base rate, market lending rates also fall. While this reduces interest burdens for customers with variable rate loans, banks see their profits decrease accordingly. For example, if mortgage rates fall from 4% to 3.5% (0.5 percentage points), a bank loses 50 million won in annual interest income on 10 billion won in loans. When profits decrease across the entire loan portfolio this way, it creates significant burden on bank management.
Second, deposit competition intensifies while funding costs may actually rise. When rates fall, customers move their money from bank deposits to stocks, funds, bonds, and other investments. The outflow of demand deposits, which pay almost no interest, is particularly serious because banks lose their cheapest funding source. Banks must raise time deposit rates or issue bank bonds to get market funding to keep customers, and all these methods increase funding costs. This creates a situation where 'interest received decreases while interest paid increases.'
Third, during rate decline periods, loan demand increases along with default risks. Lower rates make borrowing easier, increasing loan demand. But at the same time, borrowers with lower credit scores can more easily access loans, potentially increasing default risks long-term. Banks must set aside more provisions for this, creating additional cost burdens. Also, when the government strengthens lending regulations due to household debt concerns, banks face the dilemma of having demand but being unable to actually increase lending.
Banking profitability pressure during rate cut cycles becomes a structural and persistent problem.
✅ Lending Regulation Strengthening and Growth Constraints
Let's examine how household lending regulations affect banks' business models and response strategies.
First, DSR (Debt Service Ratio) strengthening has significantly reduced lending targets. With current 40% DSR regulations, someone earning 50 million won annually cannot have annual principal and interest payments exceeding 20 million won. This greatly limits possible loan amounts, excluding many potential customers from lending. Particularly in expensive metropolitan areas, even middle-class people struggle to get mortgage loans. For banks, this means the most stable and profitable mortgage lending market is rapidly shrinking.
Second, household lending volume controls have intensified competition among banks. Financial authorities limit each bank's household lending growth rate, intensifying competition for limited lending quotas. Banks increasingly lower lending rates or ease additional conditions to attract quality customers. This further pressures banks' margins. Also, stricter lending screening standards increase operational costs.
Third, banks are seeking solutions through corporate lending and overseas business. With household lending blocked, banks are focusing on the relatively less regulated corporate lending market. SME lending, project financing, and structured finance are receiving attention as new growth drivers. Also, expansion into overseas markets like Southeast Asia and Central Asia is actively pursued for growth opportunities. However, corporate lending has higher default risks than household lending, and overseas business involves risks like exchange rate fluctuations and local regulatory changes, requiring careful approaches.
Lending regulations are forcing banks to diversify their business models away from traditional household lending focus.
✅ Non-Interest Income Expansion Strategy and Future Outlook
Let's analyze the specific content and success potential of banks' non-interest income expansion strategies.
First, wealth management (WM) business is emerging as a new growth driver. In the low interest rate era, customers' investment needs are increasing, expanding banks' WM business opportunities. Particularly, private banking (PB) services for high-net-worth individuals guarantee high fee income. For example, managing 10 billion won in assets while receiving 1% annual fees generates 100 million won in stable income. Shinhan Bank and Kookmin Bank are expanding WM-dedicated centers and significantly increasing specialized staff. However, intense competition with securities firms and asset management companies, and potential high income volatility based on market conditions remain challenges.
Second, investment banking (IB) divisions are expanding high-value-added services based on expertise. M&A advisory, IPO underwriting, structured finance, and project financing provide much higher returns than simple lending. Advisory fees alone for large M&A deals can reach tens to hundreds of billions of won. Hana Bank spun off its IB division into a separate subsidiary to strengthen expertise, and Woori Bank is also expanding related organizations. However, this field requires high expertise and experience, and surviving competition with global investment banks needs considerable time and investment.
Third, digital transformation for operational efficiency improvement and new revenue creation is also an important strategy. Mobile and internet banking expansion reduces branch operating costs, while AI and big data-powered customized services increase customer satisfaction. Also, cooperation with fintech companies provides new financial services like simple payments and robo-advisors. Watching the growth of digital banks like Kakao Bank and Toss Bank, traditional banks are also accelerating digital innovation. Long-term, these changes are expected to become key factors determining banks' competitiveness and profitability.
Non-interest income expansion is essential transformation not just for short-term profitability improvement but for banking industry's long-term survival.
4️⃣ In Conclusion
The profitability crisis facing Korean banks is not simply a temporary phenomenon but reflects structural changes across the entire financial industry. Under the double pressure of low interest rate trends and strengthened lending regulations, the traditional interest spread-centered business model has reached its limits.
Net Interest Margin (NIM) decline is a clear signal that banks can no longer generate profits the same way as before. Particularly, the rising funding costs as low-cost funds like demand deposits flow out creates even greater burden for banks. In this situation, banks turning toward non-interest income expansion and corporate lending strengthening is an inevitable choice.
Expanding wealth management (WM) business and investment banking (IB) divisions provides new revenue sources short-term, but long-term, it's a change that transforms banks' very identity. They're evolving from simple intermediary roles of lending and borrowing money into comprehensive financial service providers. In this process, the gap between successful and unsuccessful banks is expected to widen further.
What's important is that these changes directly affect bank customers too. Deposit rates will become even lower, and loan screening will become stricter. On the other hand, various investment products and financial services will become more abundant. An era has come where customers must also move away from simply depositing and borrowing money to more actively utilizing financial services.
The government and financial authorities face deeper concerns too. While lending regulations for household debt management are necessary, they shouldn't lead to bank management deterioration that burdens the entire financial system. Policy wisdom is needed to guide banks toward healthy transformation through appropriate regulations and sound competition.
Ultimately, this banking profitability crisis is both a crisis and an opportunity. Banks that adapt to change will develop into more competitive financial institutions, while those that don't will inevitably be eliminated. Customers must also understand these changing trends and respond wisely.
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