Standard Chartered Plc and Citigroup Inc. (C) have seen their $6 billion bet on South Korea turn sour in less than 10 years as the two banks struggle to sustain profits in an economy plagued by rising household debt.
Standard Chartered took a $1 billion writedown on the value of its business in the country in August, a cost that’s set to end the London-based lender’s 11-year streak of record annual profits. At Citigroup, Korea will hurt revenue in Asia through 2014, Chief Financial Officer John Gerspach has said.
Korean lenders have seen their return on equity, a measure of profitability, shrink by more than half over the past decade when Standard Chartered and Citigroup first pledged the largest-ever foreign investment in the country’s financial industry. With the government stepping up efforts to curb household debt, foreign banks have been left seeking ways to cut costs.
“Banks will have to accept the new normal of low growth, low return on equity,” said Yoo Sang Ho, a Seoul-based banking analyst at HI Investment & Securities Co. “They have to forget what they saw in the mid-2000s.”
Standard Chartered, Citigroup and HSBC Holdings Plc (HSBA) first started competing for Korean banks after the economy and banking system rebounded from the 1990s Asian currency crisis that led to an International Monetary Fund bailout. In 2004, New York-based Citigroup trumped Standard Chartered to buy Koram Bank for about $2.7 billion. The following year, Standard Chartered beat HSBC in acquiring Korea First Bank for $3.3 billion.
Over the past five years, Korean economic growth slowed to 2.9 percent from an average 5.8 percent in the nine years through 2008, according to the IMF, as household debt swelled. At the same time, commercial banks saw their ROE slump to about 7.4 percent last year from 20.3 percent in 2005, according to data from the nation’s Financial Supervisory Service.
President Park Geun Hye, who took office in February, has pledged to ease consumer debt burdens by restructuring loans for low-income earners. The move follows measures already in place since 2006 limiting the amount people can borrow depending on their income and home values. In 2011, the financial regulator asked banks to provide more fixed-rate loans to reduce risks from increases in interest rates.
Bank lending rose 3.4 percent in 2012, the weakest since a drop of 0.1 percent in 1998 amid the Asian currency crisis, according to Bank of Korea data. Loan growth averaged 6.5 percent in the five years starting in 2008 after averaging about 17 percent in the previous nine years, the data show.
“Rules that limit household lending must have hammered profits at foreign banks who rely more on retail business than their domestic peers,” said Kim Hye Mi, a researcher at Seoul-based Hana Institute of Finance.
Profit of all 18 lenders in the country including Standard Chartered and Citigroup fell 42 percent to 4.8 trillion won ($4 billion) in the nine months through September as lending slumped and margins on loans shrank to a four-year low, the FSS said.
The regulator said today it had ordered Citigroup and Standard Chartered’s units to investigate allegations that staff members or contract workers sold client information to private lending agents. The FSS is waiting to hear from the two lenders before deciding whether to conduct its own probe, Lee Sang Koo, the director-general of the regulator’s bank supervision team, said by phone today.
Government measures have hit foreign banks harder than their Korean counterparts because they rely more on lending to individuals. Loans to households accounted for about 71 percent of lending at Standard Chartered Bank Korea Ltd. as of September and 61 percent at Citibank Korea Inc., according to FSS data. That’s compared with 55 percent and 45 percent, respectively at Kookmin Bank, the nation’s biggest lender by assets, and Woori Bank (053000), the second largest.
“Because of the government’s view, on the retail side you have to conduct your business in a way that’s good for clients which isn’t necessarily profit maximizing,” said Iain Clacher, an associate professor in accounting and finance at Leeds University Business School, who’s published research on the economic development since the Korean war in the 1950s. “It’s not a glamorous thing but it can be stable.”
Standard Chartered, which doesn’t provide quarterly earnings figures, said in August its Korean consumer unit posted a loss of $6 million after a $100 million profit a year ago. Consumer banking revenue in the country may drop about 15 percent this year, it said on Dec. 4, without giving details.
Net income at Citibank Korea fell 28 percent from a year earlier to 145 billion won in the nine months ended September, figures from the U.S. firm’s local unit show. Its ROE declined to 3.3 percent in 2012 from 15.7 percent in 2005, the first full year after it bought Koram Bank.
Standard Chartered and Citigroup have also struggled to compete with domestic banks operating larger customer networks.
“With the limited contact points, it’ll be tough for them to appeal to retail clients,” said Yoon Suk Heun, professor at Soongsil University’s school of finance in Seoul.
Kookmin Bank operated 1,202 domestic branches as of September, while Woori Bank had 993, according to regulatory filings. Standard Chartered’s outlets totaled 347, down from 407 at the end of 2005. Citibank Korea operated 196, compared with 238 at the end of 2004, filings show.
Citigroup’s Gerspach said on Oct. 15 that the Korean market will “continue to present a drag on year-over-year revenue comparisons for Asia through at least next year.” Still, the country “is one of Citi’s most important markets globally,” said Mark Costiglio, a New York-based spokesman.
Standard Chartered remains committed to the Korean business, with Chief Financial Officer Richard Meddings earlier this month calling it an “important economy.” The bank sold two non-core consumer finance businesses to help reduce its exposure to higher-risk unsecured loans, according to the CFO.
Shaun Gamble, a spokesman for the lender, declined to comment on any further plans involving Korea.
For its part, HSBC, Europe’s largest bank by assets, said earlier this year it plans to wind down its retail banking and wealth management business in Korea. The London-based lender failed in at least three attempts to acquire local lenders since it entered the Korean consumer market in 1998.
“The biggest problem for foreign banks was that they didn’t expand in the high-growth years right after their acquisitions, while domestic peers got bigger,” Heakyu Chang, Seoul-based director of financial institutions at Fitch Ratings, said in a telephone interview on Dec. 18. “They failed to achieve a certain size” in order to compete.
Still, leaving the market may prove expensive as the country’s tight labor laws make it difficult to cut staff. When HSBC said in July that it would close 10 of its 11 offices to focus on the global banking and markets business, it had to pay some staff more than 50 months of severance pay, according to a person familiar with the matter who asked not to be identified because they weren’t authorized to speak publicly.
Standard Chartered’s efforts to base pay on performance to become more competitive enmeshed it in the longest strike in Korea’s banking history in 2011, when about 2,700 staff walked out to protest potential job cuts.
Soongsil University’s Yoon said banks may have to find other ways to reduce costs, calling employment one of the government’s “most important tasks.” There will be “tough resistance” to any job cuts, he said.
“South Korea is too attractive a market to leave given its economic size while it’s hard to meet expectations for earnings as the banking industry is saturated,” said Kim Woo Jin, senior research fellow at the Korea Institute of Finance in Seoul. “To cope with falling profitability, they need to find ways to control costs and to provide distinctive services.”