Korea's Internet-Only Banks: Lessons from Korea's Experience By

Korea’s Internet-Only Banks: Lessons from Korea’s Experience

Sukgeun Lee

Professor Sogang Business School Sogang University Content

1. Emergence of Internet-Only Banks in South Korea

2. Experiences and achievement of Internet-Only Banks in South Korea

3. Challenges

4. Key Lessons

2 1. Emergence of Internet-Only Banks in South Korea Korean financial industry is in a weak position relatively considering the size of Korean economy that is 10th-12th in the world

Tier 1 Capital Comparison Ranking of Financial Industry (WEF 2017)

40%

35%

30%

25%

20%

15%

10%

0% 2014 2015 2016 2017

China Thailand Indonesia Hongkong South Korea

Source: The Banker, “Top 1000 World Banks 2018”, 2018.02.07

3 1. Emergence of Internet-Only Banks in South Korea Japan and China have approved ICT companies to run Internet-Only Banks in 2000 and 2013 respectively

Internet-Only Banks Differentiated competencies Shareholders • ID registration and bank account • KDDI(50%) opening by mobile • Mitsubishi UJF Financial Jibun Bank • Mobile money transfer using mo Group(50%) bile number • E-mail money transfer • Rakuten(100%) • Financial products recommendation Rakuten Bank • Credit rating using big data • Ant Financial(30%) analysis(Taobao purchase data) • Fusun Group(25%) My Bank • Wanxiang Group(10%) • High interest loan using consumer data analysis • Tencent(30%), We Bank

4 1. Emergence of Internet-Only Banks in South Korea In 2000, Japanese government has approved Internet-Only Bank to boost growth of financial industry through new technology and capital from ICT industry

Profitability of Japanese Banks Seven Bank Total Balance and Number of Accounts

1827 0.6 500 1690 1850 1562 450 1650 1405 0.4 400 1450 1214 350 1066 1250 0.2 971 300 885 1050 775 250 688 850 0 580 200 650 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 466 150 331 450 225 -0.2 163 100 63 108 250 50 50 -0.4 0 -150

-0.6

balance of time deposits -0.8 outstanding balance of ordinary deposits ROA ROE number of individual accounts

Source: Statistics in Japan Source: Seven Bank IR, 4Q 2018

5 1. Emergence of Internet-Only Banks in South Korea In 2013, Chinese Government also approved Internet-Only Bank by ICT companies to uplift the growth of stagnant financial market

Profitability of Chinese Banks WeBank Operating Income and Asset [Bn RMB]

2500 40.00% 36.33% 2200.37 35.00% 2000 30.00%

25.00% 1500 18.96% 20.00% 14.48% 15.00% 1000 9.30% 817.04 10.00% 7.80% 7.70% 519.95 5.00% 500

0.00% 96.21 100.2984 2.26 24.49 67.48 2011 2012 2013 0 Net Profit Growth Rate in Banking 2015 2016 2017 2018 GDP Growth Rate Operating Income Total Asset

Source: Statistics in China Source: We Bank IR, 4Q 2018

6 1. Emergence of Internet-Only Banks in South Korea Korean government has decided to leverage strength of internet infrastructure to stimulate the growth of Korean financial industry via fintech and Internet-Only Bank

Annual Global Fintech Deals and (Bn USD) Internet Penetration/ speed by country

45 1707 1750

40 1480 39.57 1550

35 1254 1350 1153 30 1150 885 25 950 19.29 20 18 750 16.3

15 550 Source: World Fact Book, Eurostat

10 8.34 350

5 150

0 -50 2014 2015 2016 2017 2018

financing deals Source: “2019 Fintech Trends to Watch”, CB insights , 2019

Source: OOKLA SPEEDTEST, 2017

7 1. Emergence of Internet-Only Banks in South Korea While Korea FSS has tried to introduce Internet-Only Bank, there were 2 major regulatory obstacles to overcome for the approval of the Internet-Only Bank

.1 Separation of industrial and financial capital  Non-financial companies are allowed to own 4% (or 10% non voting right) of bank‟s shares to keep conglomerates out of banking industry and to prevent misuse of consumer deposits > “Execution Plan for Internet-Only Banks” of FSC in June 2015 suggested that non-financial shareholder limit be lifted from 4% to 50%, which enables ICT companies to enter into banking industry

2. Real-name financial system  Existing law: Visit off-line branches when opening new ‘Financial Real Name Act’ bank accounts article 3-1

Financial companies are  Changed law (Dec 2015) obliged to check the real name - Verification with copy of identification card of the trader only by face to - Video call face verification - Confirmation while direct delivering (etc. credit cards) - Use existing bank accounts

8 Content

1. Emergence of Internet-Only Banks in South Korea

2. Experience and Achievement of Internet-Only Banks in South Korea

3. Challenges

4. Key Lessons

9 2. Experience and Achievement of Internet-Only Banks in South Korea FSC (Financial Supervisory Commission) has set the basics of establishment for Internet-Only Bank through „Special Act for Internet-Only Banks‟

Comparison of Banking Act and Special Act for Internet-Only Banking

Internet-Only Bank Act Banking Act

Non-financial 4% 34%* Shareholding 10% including non-voting Limit shares

Lending to major Prohibited 25% of Equity shareholder

Minimum Capital 25 million USD 1 billion USD

* It was 10% in 2015 at the launching of Internet-Only Bank, yet amended to 34% in 2018

10 2. Experience and Achievement of Internet-Only Banks in South Korea In 2017, first Korean Internet-Only Banks, K Bank and Kakao Bank, have launched

First Internet-Only Banks in Korea

K Bank Kakao Bank Initial Capital (M USD) 250 300 Staff Number 142 140 CEO Shim Sang Hoon Yoon Ho Young, Lee Yong Woo Woori Bank(10%), GS Korea Holdings(54%), Main Stakeholder Retail(10%), Hanwha Life(10%), Kakao(10%), KB Kookmin KT(8%) Bank(10%)

Banking System KT DS, Woori FIS LG CNS

Request for Permission September 30th, 2016 December 2016 Beginning of Business April 2017 July 2017

11 2. Experience and Achievement of Internet-Only Banks in South Korea Since launching, both Internet-Only Banks over-achieved their target in customer acquisition while Kakao Bank acquired customers by 9 times more than K bank

Customer Growth of Internet-Only Banks

1600 0.5 1600 44.0% 0.5

35.8% 0.4 0.4

0.3 25.0%24.4% 0.3 16.6% 0.2 0.2 12.4% 10.7% 10.1% 9.4% 7.1% 9.2% 9.1% 9.7%7.4% 5.6% 3.7% 891 0.1 4.1%3.9% 6.3% 6.0% 0.1 764 800 700 0 800 0 618 641 546 585 -0.1 -0.1 499 444 -0.2 -0.2 327

-0.3 -0.3

-0.4 56 62 68 73 76 79 84 89 98 -0.4 19 4 25 36 45

0 -0.5 0 -0.5

12 2. Experience and Achievement of Internet-Only Banks in South Korea The successful customer acquisition was possible thanks to the innovative products and services of Internet-Only banks

Innovative Services and Products

. Micro-loaning services (5.5% upto 5K usd regardless of credit rating) . Quicker credit loan (2.67% up to 100K usd 24 hr) Banking Products . Daily interest payment account (1.2% annual deposit rate for checking a/c) . Parent company linked products (not available for traditional banks)

. Fund transfer with telephone number, name, without full authentication Customer Services . Biometric Security system for enhancing securities . 24/7 Customer Services Representatives(CSR, K Bank Only)

. Simplified Opening for a new account Banking Services . Commission exemptions for withdrawal, transactions with other banks

13 2. Experience and Achievement of Internet-Only Banks in South Korea However, both K bank and Kakao bank are making loss due to heavy initial investment and aggressive offerings for lower margin such as fee exemptions

Operation Profit (loss) (M USD) Capital Impairment Ratio

2017 2018 2017 2018 0 0

-50

-100 -50%

Kakao Bank K Bank Kakao Bank K Bank

14 2. Experience and Achievement of Internet-Only Banks in South Korea Cost structure of Internet-Only Bank also shows clear inefficiency compared with those of traditional banks in terms of fee expenses and SG&A

Efficiency Analysis (M USD)

Shinhan KEB Woori Kookmin Kakao Bank K Bank Profit before allowance 0.207 0.198 0.171 0.173 (0.012) (0.182) accumulation per employee Deposit per employee 17.6 18.0 17.3 16.6 17.9 4.64 Loan amount per employee 14.1 14.3 13.8 13.5 15.1 3.36 Total employees(#) 13,639 12,795 13,683 16,729 414 299

Efficiency Analysis (Interest Expanses = 1)

Shinhan KEB Woori Kookmin Kakao Bank K Bank Interest expenses 1 1 1 1 1 1 Fees expenses 3.8% 4.8% 4.1% 7.6% 115.5% 62.5% S&GA 55.1% 75.7% 88.5% 99.6% 117.4% 346.6% Extra cost 2.8% 0.6% 10.9% 5.0% 12.7% 0.0%

15 2. Experience and Achievement of Internet-Only Banks in South Korea The inefficient cost structure expect to be improved as Internet-Only Banks extend product/ services which currently covers only partial of incumbent banks‟

Comparison of Available Services of Internet-only banks with Traditional Banks

K Bank Kakao Bank Traditional Banks General Commission fees Exemption (**) Available Available Not Available 24/7 CSR Available Not Available Not Available Public Authentication required Not Required Not Required Required Biometric Security System Available △ △ Simplified account opening Available Available Not Available

Comparison of Available Products of Internet-only banks with Traditional Banks

K Bank Kakao Bank Traditional Banks Micro-loans serviced within an hour Available Available Not Available Quicker loans Available Available Not Available Daily interest-paying account Available Available MMF Account only(*) Savings Savings - Parent Company linked product - reward linkage - reward linkage

16 2. Experience and Achievement of Internet-Only Banks in South Korea The inefficient cost structure expect to be improved as Internet-Only Banks extend product/ services which currently covers only partial of incumbent banks‟ (Cont‟d)

Intrinsic Banking Business – Defined by the South Korean Banking Act (2017) Intrinsic Business K Bank Kakao Bank Retail deposits & savings Available Available Retail loans △ △ Corporate deposits Not Available Not Available Corporate loans Not Available Not Available Issuance of securities and other debt certificates Not Available Not Available Bill discount Not Available △ Foreign exchange △ △

Incidental Services – Defined by the South Korean Banking Act (2017) Subsidiary Business K Bank Kakao Bank Debt guarantee Not Available Not Available Acceptance of draft Not Available Not Available Factoring Not Available Not Available Syndicated loan Not Available Not Available RP - Government/Public debt transaction Not Available Not Available Stock lock-up Not Available Not Available Safe deposit box Not Available Not Available FX transactions Not Available Not Available Payment agent Not Available Not Available Financial task intermediary – for other institutions Not Available Not Available

17 2. Experience and Achievement of Internet-Only Banks in South Korea The inefficient cost structure expect to be improved as Internet-Only Banks extend product/ services which currently covers only partial of incumbent banks‟ (Cont‟d)

Concurrent Business – Defined by the South Korean Banking Act (2017)

Business K Bank Kakao Bank Trust Not Available Not Available Credit Card Not Available Not Available Check-Card (Debit Card) Available Available Wealth management corporation task/Sales intermediates △ Not Available

18 Content

1. Emergence of Internet-Only Bank in South Korea

2. Experience and Achievement of Internet-Only Banks in South Korea

3. Challenges

4. Key Lessons

19 3. Challenges Legal and Regulatory – Deregulation of separation of industrial and financial capital

Arguments against the separation

1) Although it was necessary for government to control capital for optimal distribution for industrial development in early „60s and „70s, such need for government intervention became weak as capital is overflowing in most of conglomerates

2) There is also insufficient need for conglomerates to raise capital via their own bank as capital market grow bigger and more efficient for direct funding

3) If regulation of separation of industrial and financial capital restricts 10% of bank shares and 4% voting rights, this will not only block capital infusion from ICT companies into internet-only banks but also discourage entering of ICT firms in banking industry

4) Limitation of capital infusion will affect BIS maintenance of Internet-only bank, which then directly relates to the operation of banks in both lending and deposit

On Oct 16, 2018, the National Assembly finally amended the Banking Act only for internet-only banks and passed the “Act on Special Cases Concerning Establishment and Operation of Internet-Only Banks”, which allow the limit of industrial capital shares increase up to 34%

20 3. Challenges Legal and Regulatory – Bank Major Shareholder Qualification Issue

Eligibility check by FSC and violation of the Monopoly Regulation Fair Trade Act

Act on Corporate Governance of Financial Companies regulates qualification of major shareholder in any kind of bank and FSC must confirmed that there is no eligibility issues under following checklists

Regulation by the Act on Corporate Governance of Financial Companies Disqualification of major shareholder; in case of following violation - Banking Act - Capital Market and Financial Investment Business Act Eligibility - Act on the Aggravated Punishment of Specific Economic Crimes (e.g. checklist Seizure, Breach of duty, Money Laundering) - Monopoly Regulation and Fair Trade Act - Punishment of Tax Evaders Act KT Charges KT has a record of violation related to the ‘ Monopoly Regulation and Fair Trade Act ’ President of Kakao’s board was convicted on suspicion of the ‘ Monopoly Regulation Kakao Charges and Fair Trade Act ’

While Kakao Bank‟s eligibility issues has been resolved, which enabled capital infusion from the kakao bank‟s parent company up to 34%, KT eligibility issue has been pended so far, which blocked capital injection by KT, parent company of K Bank and hampered banking service seriously

21 3. Challenges Legal and Regulatory – Privacy law vs Big Data based CSS

Privacy Law blocking the access of Internet-Only Bank to BHC (Bank Holding Company)‟s data

Korean privacy law states, “Private information with individual identification code should not be transferred into other firms unless customers granted it so”

Privacy law as obstacle for big data based CSS of Internet-Only Banks

. KT(Tele-communications) . Kakao(Social Networks) Parent Can’t access Internet . Distributors companies BHC’s data Only Bank . Existing Banks . Investment Banks, Etc..

The National Assembly could not pass deregulation of the privacy law in 2019

22 3. Challenges Operations – Complicate Governance Structure

Governance Structure of Internet-Only Banks

Kakao Bank‟s 11 shareholders K Bank‟s 19 shareholders

Korea Investment Holdings Others KB Kookmin Bank Danal Kakao KG Inicis Skyblue(Tencent) GS Retail Ebay Korea Hanwha Life Insurance Korea Post NT Investment & Securities Seoul Guarantee Insurance KT Nermarble Woori Bank Yes24 0 5 10 15 20 25 30 35 40 0 10 20 30 40 50 60 70

“Complicated governance structure can cause delay of decision due to the potential conflict of interests among shareholders, which will be issue especially when the banks need to make major decision quickly”

* K Bank has history of failure in relation to raising capital twice. (2018 02, 2018 07)

23 3. Challenges Operations – Slower growth of customer

Growth of Kakao Bank‟s customer Growth of K Bank‟s customer

44.0% 35.8% 25.0% 24.4% 0.4 0.4 16.6% 10.7% 9.7% 10.1% 12.4% 9.4% 9.2% 9.1% 1200 7.4% 4.1% 3.9% 6.3% 6.0% 0.2 1200 7.1% 5.6% 3.7% 0.2

891 0 764 700 -0.2 800 -0.2 800 618 641 546 585 499 -0.4 444 -0.4 327 400 -0.6 400 -0.6

-0.8 84 89 98 -0.8 45 56 62 68 73 76 79 19 4 25 36

-1 0 0 -1

Source: Kakao Bank Source: K Bank

Both Internet-Only Banks are experiencing problem of slower growth of customers, which is causing problem of BEP (Break Even Point) management

24 3. Challenges Competition – Traditional Banks‟ reaction against Internet-Only Banks

New Mobile Services Platforms of Traditional Banks

Shinhan KEB Woori Kookmin Mobile Services Platforms of Traditional Banks

. User-friendly (customized) platforms (Common)  Provide personal-customized banking systems

Main  Robo-Advisor to recommend services (KEB) Benefits . Provide special benefits relating the bank‟s products & services  FX transaction fees discount (KEB, Shinhan, Kookmin)  Providing higher deposit rate (Woori, Shinhan, Kookmin)

New Mobile Banking Service Platforms introduced by traditional banks narrow gap between offerings of traditional banks and Internet-only banks‟ 25 3. Challenges Competition – Increasing efficiency of traditional banks

Offline branch reduction of traditional banks

K Bank launch Kakao Bank launch

End of 2016 June, 2017 End of 2017 End of 2018 Kookmin 1061 1066 996 981 Woori 862 887 826 819 KEB 867 819 767 726 Shinhan 854 899 834 805 Total 3604 3671 3423 3331 Change 27 -248 -92

Traditional banks have reduced branches substantially (92 in 2018, 66 until 3Q 2019) after launch of Internet-Only Banks, which decrease costs and increase investment for digitalization of the banks including mobile channel and new services that neutralize the differentiated products/services of Internet-only banks. Such impacts on the incumbent banks by internet-only bank are called „CATFISH‟ effect

26 3. Challenges Competition – New Entries

New Entries

Main Candidate Industry Reason for Rejection in 1st round . Capital financing adequacy issues Fintech  Main partner, US VC(Altos Ventures)‟s (Mobile Transfer) adequacy as bank shareholder is questioned  Feasibility of initial capital injection for bank is questioned

Investment Bank . Innovation issues  Innovative feature of BM is questioned  Simple summation of Investment bank and Commercial bank is not innovative enough?

“FSC announced that they would license 3rd and/or 4th Internet-Only Bank in 2019”

27 Content

1. Emergence of Internet-Only Bank in South Korea

2. Experience and achievement of Internet-Only Banks in South Korea

3. Challenges

4. Key Lessons

28 4. Key Lessons Key Lessons – What worked well and What needs to be improved

What Worked Well What needs to be Improved

Customer Acquisition Regulatory alignment • 120 days to acquire 1 million customers • Better alignment of new policy with (K Bank) existing regulatory framework could • 2 days to acquire 1 million & 8 days for mitigate uncertainty to the management of 2 million customers (Kakao Bank) Internet-Only banks and bank customers Differentiated products/servicies Positive Influence on traditional banks • Insufficient introduction of innovative • Competitive rates (higher deposit, lower products/services lending rates) offers benefit to • Customer profile, product portfolio, mobile customers and lowered rates of channel is not differentiated enough traditional banks • Continued off-line branch reductions Improved CSS increases cost efficiency of traditional • No clear advantages from CSS that is banks supposed to be developed on big data • Digitalization of traditional banks • Privacy law banned customer information triggered access within BHC

29 4. Key Lessons More opportunities for Internet-Only banks, consumers, and financial industry are coming for win-win

More Collaboration with fintech firms • Internet-only banks with various non-financial shareholders will be able to collaborate with various shareholders and fintech firms more easily than traditional banks • Collaboration with fintech firms and formation of open innovation with them will provide source of innovation

More market entries • As number of Internet-only bank increases, it will stimulate competition among banks and bring more capital to financial industry and more benefits to financial consumers

Continued innovation: techfin vs fintech

• More innovative technology will be available, which will lead more innovation for financial products/services that will attract more customers and go beyond scope of regulation and business domains of financial industry