Posted Date : 17 Oct 2008

MARC is issuing this special comment on the South Korean banking system following the heavy media coverage on the possible heightened vulnerability of its banks to the global credit crisis stemming from their funding structure. The rising USD funding costs and the shortage in USD funding supply pose immediate challenges for South Korean corporates and banks which are facing significant USD debt maturities in coming quarters. To avert funding shocks and increased uncertainty surrounding the funding profile of domestic banks, South Korea financial regulators, the Financial Services Commission (FSC) and the Bank of Korea, have pledged prompt supply of foreign exchange liquidity into the USD/Won swap market as and when required and has proceeded to inject USD into the domestic USD/Won swap market. The South Korean Government, which has the world’s sixth largest foreign exchange reserves at nearly USD239 billion, has provided USD to domestic banks and exporters facing USD shortages. 
 
South Korean banks have increasingly relied on wholesale funding to grow their loans due to shrinking deposit bases in recent years. At the same time, MARC understands that the flight of deposits from banks in pursuit of higher-yielding investments has abated this year due to heightened equity market volatility at home and abroad, as well as the bank’s efforts to offer higher rates on time deposits. Banks have also been issuing long term certificates of deposits (CDs) and bonds to improve funding stability. The Financial Supervisory Service (FSS) monitors the ‘foreign currency liquidity ratio’ – a measure of capacity to repay short-term foreign currency debts of its domestic banks on an ongoing basis. We believe that the ratio remains within prudential limits established by the FSS based on a recent press release jointly issued by the FSC and the FSS which disclosed the ratio of won-denominated loans to deposits including CDs at 103.2% as at end-September 2008. The close monitoring and the authorities’ acknowledged need to deal with the situation in a pre-emptive manner provide continued assurance of timely liquidity intervention. In fact, back in August 2007, the Bank of Korea had already tightened the rules of foreign currency lending to residents by limiting the usage of foreign currency loans for overseas use.
 
While some measure of deterioration in asset quality could arise from a sharper than anticipated fall-off in economic growth, MARC draws comfort that the banks are entering into this challenging phase with low non-performing loan (NPL) levels. Furthermore, the regulatory authorities have been taking defensive measures to curb household credit growth for some time, particularly in respect of mortgages. As a result, we note that average loan-to-value ratios remain low. As in any market, vehicle loans, unsecured personal lending and credit cards are most at risk to deterioration in household repayment capacity due to weaker economic conditions. Hence, non-bank consumer finance companies may be more vulnerable to external shocks and may not benefit from a similar level of intervention by the authorities. Corporate and SME delinquency rates remained at healthy low levels in the first half of 2008. Nevertheless, it is acknowledged that the health of South Korea’s corporate sector may be affected by weaker economic conditions in recent and coming months. Bank of Korea lowered its base rate to 5.00 percent on October 9, 2008, from a 7½-year high of 5.25 percent set in August, when mounting inflation expectations were the primary concern of the central bank.
 
The combination of the slump in the Won to its lowest level since 1998, a plunge in the stock market and a deteriorating current account balance poses major challenges to the South Korean economy. While consumer inflation is unlikely to slow remarkably in the fourth quarter, we expect inflationary pressures to gradually recede with the fall in commodity prices and weaker domestic demand. The recent slump in the Won is a combination of factors including net sales of domestic shares by foreign investors, activity in the non-deliverable forwards market, and the current account which showed a record deficit in August 2008 largely due to high prices of commodity imports. The current account situation is expected to improve with falling oil prices (South Korea is the world’s fifth largest crude buyer) and relatively resilient exports to the end of the year. The authorities are expecting the Won to stabilize as the current account posts a surplus for the fourth quarter 2008. 
 
Currently, MARC has AAA/AAAID long-term ratings on The Export-Import Bank of Korea’s (KEXIM) RM3.0 billion Conventional/Islamic Medium Term Notes Programmes. Wholly-owned by the South Korean government, KEXIM is a specialist provider of export financing and benefits from an explicit statutory support of the sovereign to maintain KEXIM’s solvency. MARC also maintains a AAA rating on Woori Bank’s RM1.0 billion Medium Term Notes Programme. Woori Bank, the third largest commercial bank in Korea based on asset size, is majority owned by the government. In addition to strong credit fundamentals of both financial institutions, the ratings and stable rating outlooks on KEXIM and Woori Bank continue to reflect MARC’s expectation of forthcoming and timely credit support from the Korean government for both entities in a distress scenario given their ownership profiles.

MARC believes that pro-active regulatory intervention by the South Korean authorities will be an important contributor to the overall resilience of the South Korean banking system to current systemic stress. MARC will continue to monitor the developments on the external and domestic front and issue updates accordingly.

Contact: 
Milly Leong 03-2090 2288/ milly@marc.com.my 
Esther Ee 03-2090 2270/ esther@marc.com.my