[1mm Financial Talk] Banks' Profitability Falls Despite Consecutive Base Rate Hikes... Why?

NIMs at all four major banks fall... down as much as 0.07 percentage points
Funding costs rise despite higher lending rates
RWA declines as exchange rate falls to the 1,300-won range
Exchange rate effect cuts RWA by up to 11.9 trillion won... boosts CET1 ratios by 0.1-0.46 percentage points

Banks posted record-high cumulative results for the first three quarters, but profitability indicators actually deteriorated. This was contrary to expectations that margins would widen as lending rates rose following the Bank of Korea's consecutive base rate hikes in July and August. Although lending rates increased, funding costs rose at the same time. The won's appreciation against the dollar, with the exchange rate falling into the 1,300-won range, also had a significant impact: the risk-weighted assets (RWA) of all four major financial groups declined.

According to the financial sector on November 2, the net interest margin (NIM) of the four major banks (KB Kookmin, Shinhan, Hana and Woori) fell across the board as of the end of September compared with the previous quarter. Specifically, the figures declined as follows: KB Kookmin Bank, 1.94% to 1.92%; Shinhan Bank, 1.61% to 1.58%; Hana Bank, 1.61% to 1.57%; and Woori Bank, 1.506% to 1.434%. Woori Bank recorded the largest decline, at 0.072 percentage points. NIM is a key indicator of a bank's profitability from interest income. It is calculated by dividing net interest income, which is interest income minus interest expenses, by average interest-earning assets.

With the base rate raised twice consecutively in July and August, the market had expected the banking sector's profitability to improve in the third quarter. In fact, according to the Bank of Korea, the average interest rate on loans extended by banks rose by 0.26 percentage points, from 4.31% at the end of June to 4.57% at the end of September. Rates on corporate loans rose by 0.22 percentage points, while the average rate on household loans increased by 0.46 percentage points, from 4.50% to 4.96%.

The decline in banks' interest profitability despite rising lending rates was due to a narrower gap between lending and deposit rates. At Woori Bank, which disclosed the figures, the interest rate on won-denominated loans rose by 0.08 percentage points, from 3.91% to 3.99%, while the interest rate on won-denominated deposits climbed by 0.16 percentage points, from 2.06% to 2.22%—a larger increase. In other words, funding rates rose more sharply, offsetting the profit gains from higher lending rates.

Funding conditions for banks were challenging in the third quarter. Core deposits fell as money moved into the securities market. According to Meritz Securities, total bank time deposits increased by 65 trillion won quarter on quarter, while demand deposits and other deposits withdrawable at any time fell by 70 trillion won. As competition for deposits intensified, the share of deposits paying annual interest rates of 3% or more rose from 33% in May to as high as 70% in August. The expansion of won-denominated lending, largely driven by corporate loans, which saw relatively smaller rate increases, also appears to have constrained the rise in lending rates.

By contrast, the four major financial groups benefited considerably from the decline in the exchange rate. The won-dollar exchange rate fell by 196.6 won, from 1,549.4 won at the end of June (based on the weekly closing rate) to 1,352.8 won at the end of September, and the RWA of the four groups also declined substantially. The four major financial groups had total RWA of 1,266.3027 trillion won at the end of the third quarter, down 19.8064 trillion won, or 1.54%, from 1,286.1091 trillion won in the previous quarter. Hana Financial Group saw the largest decline, at 10.589 trillion won, while Shinhan Financial Group's RWA fell by 5.7574 trillion won. KB Financial Group's declined by 1.761 trillion won, and Woori Financial Group's by 1.699 trillion won.

The decline in the exchange rate was the biggest factor behind the reduction in RWA. The decrease in RWA attributable to the lower exchange rate was estimated at 11.9 trillion won for Shinhan Financial Group, 7.4 trillion won for Woori Financial Group and 3.7 trillion won for KB Financial Group. This boosted their Common Equity Tier 1 (CET1) ratios by 0.1 to 0.46 percentage points.

A financial industry official said, "The exchange rate has not fallen as much in the fourth quarter, so its effect on RWA and the CET1 ratio may not be as significant as it was in the third quarter. Given that competition among banks for deposits is easing and the impact of higher lending rates could fully materialize in the fourth quarter, NIM is likely to improve going forward."

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