Financial Holding Companies Face High Exchange Rate Risks Ahead of Productive Finance Shift... Soundness Management on High Alert

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With the won-dollar exchange rate surpassing the 1,470-won mark and reaching its highest level in seven months, banks and financial holding companies are on high alert to manage their financial soundness. The rise in the exchange rate is a factor that lowers the Common Equity Tier 1 (CET1) ratio, which directly affects shareholder returns. This is especially burdensome as, starting next year, the financial sector is preparing for a major shift toward "productive finance," requiring capital ratios to be raised as much as possible. As the high exchange rate is expected to persist for the time being, managing capital ratios is likely to become even more challenging for financial institutions.

According to the financial industry on November 25, as of the end of the third quarter, two of the four major financial holding companies-Shinhan Financial Group and Hana Financial Group-saw their CET1 ratios decline compared to the previous quarter. Shinhan Financial Group's CET1 ratio fell by 0.06 percentage points from 13.62% in the previous quarter to 13.56% in the third quarter. Hana Financial Group's ratio dropped by 0.09 percentage points from 13.39% in the second quarter to 13.3%. In contrast, KB Financial Group and Woori Financial Group recorded CET1 ratios of 13.83% and 12.92%, respectively, in the third quarter. KB Financial Group's ratio increased by 0.06 percentage points, while Woori Financial Group's rose by 0.1 percentage points over the same period.

The decline in CET1 ratios for some financial holding companies is attributed to the rise in the exchange rate. The increase in the won-dollar exchange rate leads to a rise in risk-weighted assets (RWA), which in turn hinders the management of CET1-a key indicator of the financial soundness of holding companies. In other words, the exchange rate rise inflates the value of foreign currency assets, which have high risk weights, and results in a lower CET1 ratio, calculated by dividing common equity capital by risk-weighted assets. In the banking sector, it is known that a 10-won increase in the won-dollar exchange rate leads to a decline in the CET1 ratio by approximately 0.01 to 0.03 percentage points.

In fact, as of the end of September, Shinhan Financial Group's RWA stood at 348 trillion won, an increase of 8 trillion won from the previous quarter. This was due to the increase in foreign currency-denominated assets and RWA resulting from the higher exchange rate. For Hana Financial Group as well, despite growth in fee income during the third quarter, the impact of the exchange rate rise led to the reflection of approximately 45 billion won in foreign exchange losses.

While Shinhan Financial Group and Hana Financial Group managed to keep their CET1 ratios in the 13% range, the high exchange rate is expected to persist, so the focus on soundness management among the four major financial holding companies and banks is likely to continue. This is particularly important because, starting next year, the financial sector will significantly increase its injection of risk capital, necessitating the maximization of capital ratios. Over the next five years, the four major financial holding companies have announced plans to inject a total of 400 trillion won into productive finance: Woori Financial Group, 80 trillion won; Hana Financial Group, 100 trillion won; and both KB Financial Group and Shinhan Financial Group, 110 trillion won each.

As the high exchange rate is expected to continue for the time being, financial holding companies and banks are responding by maintaining a constant crisis response mode and strengthening exchange rate monitoring. Woori Financial Group conducts CET1 ratio simulations based on exchange rate impacts through a monthly group crisis response council and continues to reduce CET1 sensitivity by managing exchange rate-sensitive assets. KB Financial Group is managing its foreign exchange position exposure by implementing currency hedges to minimize foreign currency translation gains and losses, excluding investment profit and loss, at the group level. A KB Financial Group official stated, "Given the ongoing volatility in the won-dollar exchange rate this year, we are taking proactive measures at the group level," adding, "For KB, the CET1 ratio changes by about 2 basis points (1bp = 0.01 percentage points) for every 10-won movement in the exchange rate."

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Kang Seunggeon, a researcher at KB Securities, analyzed, "The rise in the exchange rate not only results in foreign exchange valuation losses in non-interest income but also acts as a factor that lowers the CET1 ratio, which inevitably affects shareholder return rates set based on CET1. Due to higher growth and the impact of the exchange rate rise compared to the first half of the year, it is inevitable that the CET1 ratios of financial holding companies in the third quarter will decline slightly compared to the second quarter. A sharp surge in the exchange rate will inevitably have a negative impact on the stock prices of the banking sector."

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