Even the President Steps In to Criticize... The Bank's Defense as a Public Enemy [Bank Interest Business]

As countries around the world raise interest rates amid global inflation, commercial banks are being labeled as 'public enemies.' While financial consumers are becoming 'interest poor' (loan poor) due to soaring interest rates, banks are being criticized for focusing solely on 'interest business.'

Recently, pressure has increased with statements from Financial Supervisory Service (FSS) Governor Lee Bok-hyun and even President Yoon Seok-yeol emphasizing that "during periods of rising interest rates, the interest burden on financial consumers should not be significantly increased." Amid this, commercial banks are actively considering lowering loan interest rates but argue that much of the public perception is based on 'misunderstandings.'

◆ Loan Interest Rates as the Hare, Deposit Interest Rates as the Tortoise? = The core criticism of the interest business is that banks are pursuing profits through the loan-deposit interest rate spread by 'swimming with their feet on the ground,' exploiting the difference between deposit and loan interest rates during periods of rising rates.

Financial consumers' complaints are similar in context. While deposit interest rates rise slowly and remain low, loan interest rates increase quickly and sharply, leading to criticism that banks are excessively pursuing profits.

The banking sector insists this is a misunderstanding. Contrary to common belief, banks base their interest rate calculations on market rates rather than the benchmark rate. A financial industry official explained, "Deposits usually reference short-term instruments like government bonds or negotiable certificates of deposit (CDs), while loan interest rates are based on long-term instruments such as 5-year financial bonds or COFIX (Cost of Funds Index), so there is a difference. During periods of rising interest rates, long-term rates tend to increase more."

The banks also mention a perceptual effect. Deposits are often set on a one-year basis, making it difficult for consumers to feel the impact of rate hikes, but mortgage loans (variable rate) adjust every six months, so consumers inevitably feel the effect more strongly. A banking official said, "In reality, when rates rise, deposit rates increase first, and loan rates tend to follow according to the COFIX announcement schedule."

Nonetheless, the loan-deposit interest rate spread continues to widen. According to the Bank of Korea, the loan-deposit interest rate spread based on balances at deposit banks was 2.35 percentage points in April, marking the largest gap in 3 years and 10 months since June 2018 (2.35 percentage points).

To narrow the spread, options include raising deposit rates or lowering loan rates, but artificial intervention is criticized for causing adverse effects. Raising deposit rates would be positive for consumers interested in savings and deposits, but since deposit rates are reflected in COFIX, which serves as the benchmark for variable mortgage loan rates, the burden ultimately shifts to borrowers.

Lowering loan rates is also not easy. During periods of rising rates, the number of vulnerable borrowers is likely to increase, so banks need to strengthen their loss absorption capacity. A commercial bank official said, "Recently, accumulated non-performing loans from the COVID-19 pandemic period have been increasing, and financial authorities are demanding higher provisions. Under these circumstances, it is not realistic to lower loan rates recklessly."

According to the FSS, the loan loss provisions and reserves accumulated by commercial banks stood at about 37.6 trillion won as of the end of last year, an increase of 1.8 trillion won compared to the previous year. The loan loss provision ratio (total loan loss provisions / non-performing loans (loans below fixed grade)) exceeds 190%. Financial authorities are demanding additional provisions, citing the possibility of an increase in non-performing loans (NPLs) following the end of COVID-19 financial support in the second half of the year.

◆ Soaring Net Interest Margin (NIM)?... "It is Fluid Depending on Market Conditions" = In the first quarter of this year, the combined net income of the four major financial holding companies?KB, Shinhan, Hana, and Woori?was 4.6399 trillion won. This marked a 17% increase compared to the same period last year and surpassed 4 trillion won for the first time. While securities firms' performance was sluggish due to a stagnant stock market, the rise in benchmark interest rates led to higher bank loan rates, increasing NIM.

NIM is a representative profitability indicator for banks, calculated by subtracting funding costs from total interest income and dividing by interest-earning assets. As mentioned earlier, with the loan-deposit interest rate spread at 2.35%, the highest in over three years, there are criticisms that commercial banks are enjoying excessive interest income.

The banking sector argues this is also largely a misunderstanding. Since many bank deposits are fixed-rate products while loans are mostly variable-rate products with greater fluctuations, NIM naturally rises during periods of increasing interest rates. Additionally, as COVID-19 has lasted over two years, credit risk has increased, especially among small business owners and self-employed individuals, leading to higher loan rates. The increase in mid-interest rate loans, mainly from internet-only banks, also plays a significant role.

Moreover, NIM is lower than that of major U.S. banks. The NIM of the four major domestic banks in the first quarter ranged from 1.49% to 1.66%. In contrast, major U.S. banks such as JPMorgan, Bank of America, Citi, and Wells Fargo are estimated to have NIMs between 1.6% and 2.1%.

◆ 'Opaque' Interest Rates... "Transparency Needed" = Distrust in the interest rate determination process is another factor constraining banks. Governor Lee's remark that "banks need to calculate and operate interest rates based on reasonable and transparent standards and procedures" is representative.

Generally, loan interest rates are autonomously calculated by each bank by adding various risk premiums, costs, and margins to the loan benchmark rate. The focus of criticism is the so-called 'opaque interest rates'?the additional margin.

The additional margin consists of ▲'costs' such as risk premium, credit premium, capital costs, operational costs, and legal costs ▲'margin' reflecting target profit rates ▲'adjustment rates' including discounts for ancillary transactions, head office adjustments, and branch manager approvals.

Since each bank autonomously decides, the level of additional margin varies widely. According to the Korea Federation of Banks, as of the end of May, the additional margin for general unsecured loans (credit rating 1-2) at the five major commercial banks (KB Kookmin, Shinhan, Hana, Woori, NH Nonghyup) ranged from 2.62 to 3.63 percentage points, and adjustment rates ranged from 0.37 to 1.83 percentage points. Politicians across party lines are pressuring banks, claiming they easily earn interest income through these 'opaque' additional margins.

Banks argue that interest rates should be understood as a product. A commercial bank official said, "Just as electronics and automobile companies do not disclose the cost of each component, banks' specific interest rate calculation methods are inevitably trade secrets," adding, "Having experienced difficult times such as the foreign exchange crisis and financial crisis, financial authorities' controls have been strengthened, and banks are cooperating well."

However, as criticism of the interest business intensifies, banks are also cautious, adjusting additional margins. K-Bank lowered mortgage and jeonse loan interest rates by 0.41 percentage points on the 21st, and other commercial banks are reportedly considering various measures.

The loan-deposit interest rate spread disclosure system, promoted by the government and ruling party, is expected to be introduced as early as the fourth quarter. It will disclose the difference between deposit and loan interest rates by bank and month, dividing individual credit scores into 20 segments via the Korea Federation of Banks website.

◆ Interest Income Exceeds 80%... "Seeking New Paths" = Banks are also criticized for focusing excessively on traditional interest income rather than pioneering new businesses. According to the FSS, domestic banks' interest income in the first quarter increased by 16.9% (1.8 trillion won) year-on-year to 12.6 trillion won. Meanwhile, non-interest income dropped to 1.3 trillion won, about half compared to the same period last year.

A report released last month by the Korea Institute of Finance titled 'Analysis and Implications of Non-Interest Income Sources of Domestic Bank Groups' also highlights this issue. According to the report, the non-interest income of seven bank groups?KB Kookmin, Shinhan, Hana, Woori, BNK, DGB, and JB?was 11.2 trillion won, accounting for only 19.2% of total profits. Interest income accounted for 80.8%. Considering that the non-interest income ratio of the world's top 100 financial companies is 40.8%, this is less than half. For banks that are not financial holding companies, the non-interest income ratio is only 14.4%.

However, the banking sector fundamentally emphasizes the public role of banks and explains that under the regulatory industry perspective, there is little room for business changes. Strict separation of banking and commerce (geumsan bunri) limits the expansion of ancillary businesses and restricts subsidiaries' industries, making it difficult to seek new revenue sources.

A commercial bank official said, "U.S. banks have various revenue sources, including custody fees for holding money, and investment banking (IB) activities are much more active than in Korea, so they are not overly dependent on interest income," adding, "Domestic banks are seeking new paths through overseas expansion and collaboration with various companies, but unless regulations like geumsan bunri are eased, the effects will be limited."

Kim Woo-jin, senior research fellow at the Korea Institute of Finance, explained, "Most non-interest income comes from fees, which face growth limits due to customer resistance and market competition," adding, "It is necessary to pursue growth through mergers and acquisitions (M&A) and strategic alliances, and policy authorities should support this flexibly."

Reporters Yu Je-hoon and Lee Min-woo kalamal@