Can South Korea's web-only banks break out of beginner's rut to ensure sustainability?

The two players have been booking losses as they ramp up IT spending.

After an explosive debut in mid-2017 that saw its userbase balloon to 300,000 in the short span of 24 hours, South Korea’s web-only lender kakaobank booked a cumulative net loss of $59.79m (KRW66.8b) by end-September. In the same thread, digital rival K bank was hit by a similar loss of $35.14m in the first half of the year owing to intensified spending for its IT infrastructure needs.

Given the nascent stage of the internet-only banking business in the country, the losses are expected to continue in the near term as the banks’ sales volume fail to reach break-even point, according to Ki Jun Sung, financial services leader at Deloitte Korea.

In fact, to achieve profitability this early in the business would be unheard of as any beginning corporate would still have to invest heavily in infrastructure and manpower for its operations. Japanese web-only banks took around five years before they were able to start seeing cash flow back into their balance sheets. “There are no banks in world have generated net income in the first year of business launch as they had to invest a chunk of money to set up IT infra and to hire staff. At same time, it takes time to see sizable loan asset that generate interest incomes,” said Phil Lee, manager of public relations at kakaobank.

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As they struggle to plug losses, Korea’s digital banking upstarts may receive a boost from a revised bill submitted to the National Assembly in August allowing tech firms to increase their stake in the country’s web only banks. The bill effectively makes it easier for the two players to raise capital for their asset and loan growth requirements after their strong launches quickly drained their supply.

“This would be positive and will support growth of digital banks. Current law limiting voting stakes of non-bank corporates to just 4% has been a constraint to the capital raising and therefore the growth of digital banks in Korea,” said Sophia Lee, senior credit officer, financial institutions group at Moody’s Investors Service.

Korea Investment Holdings works in close collaboration with popular messaging app Kakao to manage kakaobank's operations whilst K Bank is ran by telco company KT. Greenlighting the bill may entail that these players can achieve a scale enabling them to pose a formidable threat to the country’s old-guard banks.

“The proposed legislation (to allow more corp. parent ownership) could help internet-only banks achieve stronger business growth, supported by timely capital injections from the tech parent companies. These banks may be able to focus on introducing more innovative banking services and targeting new customer segments,” S&P global ratings banking analyst Hong Taik Chung commented.

Without the bill, banks would remain struggling to fill capital shortages that could hamper their growth prospects with K Bank’s total capital adequacy ratio of K bank declining to 10.7% as of end June whilst its risk weighted assets surged by 84% YoY.

This is because the capacity of web-only banks to boost sales volume is closely tied to their capital increase, noted Deloitte’s Jun Sung, which in turn determined by the ownership structure and financial capability of shareholders.

With President Moon backing the legislation and the ruling party view’s changing positively, banks are expressing hope that the bill would hurdle Congress. “[k]akaobank hopes the ongoing discussion goes through well as if Kakao’s shareholding goes higher, it is expected that there will be more synergy effect created by closer cooperation between kakaobank and Kakao, which will help in providing more benefits to our customers,” added Lee.