Moody's: Korean banking system outlook stable, asset quality troubled by tail risk

Moody's Investors Service says that its outlook for Korea's banking system is stable, as GDP growth remains stable and asset quality recovers slightly from 2014. Moody's outlook was last changed in 2010.

Moody's analysis is contained in its just-published report "Banking System Outlook: Korea," an overview of credit trends affecting the banking system in the next 12-18 months.

Moody's rates seventeen banks in Korea.

"Our stable outlook, unchanged since 2010, reflects our expectation of a stable operating environment for banks in the next 12 to 18 months and strong systemic support," says Sophia Lee, a Moody's Vice President-Senior Analyst. "But we note that banks' asset quality faces tail risks from problematic sectors plagued by overcapacity, although we expect stable asset quality relative to 2014."

Although the low interest rate environment supports asset quality, Korean banks face contingency risks from corporate borrowers in industries facing long-term challenges, such as construction, shipbuilding and shipping, says Moody's.

Moody's says that in 2015, bank profitability will deteriorate slightly from already low levels due to compression in net interest margins, while improvement funding and liquidity conditions will be maintained, supported by regulations and Korea's strengthened external position.

Moody's forecasts GDP growth at 2.5%-3.5 % for 2015, creating a stable operating environment. This will help keep asset quality largely stable, with nonperforming loans formation forecast at around 1.5%-2% of loans in 2015, compared to 1.6% in 2014 and 2.3% in 2013, says Moody's. Declining interest rates and policy measures to boost liquidity will support borrowers' debt servicing ability.

Moody's notes that the high level of household debt to disposable income, which was at 156% in 2014, mainly affects banks through the persistent negative effect on domestic demand, rather than by posing a large direct risk to banks' asset quality.

Funding and liquidity for Korean banks will be stable, as banks reduce their reliance on short-term and wholesale borrowing. Moody's notes that Korean banks are extending the maturities of their foreign-currency debt and increasing foreign-currency deposits.

In addition, Korea's strong support system is a positive factor for the stable outlook, says Moody's. With no defaults since the Asian financial crisis in the late 1990s--when the authorities used capital injections and other liquidity mechanisms to support vulnerable banks--Moody's expects that the government will also use pre-emptive capital injections to resolve troubled banks in Korea if necessary.

Moody's ratings of Korean banks already incorporate an average of 3.9 notches of uplift from assumptions of systemic support.