External Debt Improvement To Cap Won Downside
South Korean banks' efforts to improve their funding structure appear to be gaining traction. According to a recent report by the country's Financial Supervisory Service (FSS), Korean banks' appear to be making significant headway in their endeavours to alter their external debt profile. Domestic banks have not only been paring back on their foreign-currency borrowings, but more importantly, the share of short-term borrowings has been declining. As seen in the accompanying chart, short-term borrowings now account for 18.1% of banks total foreign currency-denominated borrowings, compared to 50.1% in 2008 as banks continued to borrow long-term to pay off short-term debt. Additionally, banks have been widening their pool of lenders while also trimming their borrowings from lenders in Europe (see chart) and increasing their borrowings from Asia and North America.
|Boding Well For Banks|
|South Korea - Domestic Banks' Foreign Debt Profile|
The improvement in Korean banks' funding structure chimes with the country's endeavours to scale back on its dependence on foreign capital, which, is one of the root causes of the volatility that the country's financial markets face in times of economic uncertainty. To be sure, as at end-2012, short-term external borrowings accounted for 32% of the country's gross external debt, down materially from a 2008-peak of 52%. From a foreign exchange perspective, while we remain bearish on the domestic currency, the structural improvement in the debt structure suggests to us that we are unlikely to witness a major selloff in the Korean won.
|A Structural Positive|
|South Korea - Gross External Debt, US$bn|
Broadly speaking, we believe the fundamental change in the country's debt structure bodes well for the economy going forward. Such is the case that this has boosted the attractiveness of Korean government debt, particularly by overseas sovereign investors, which, if sustained, would augur positively for the Korean won and by extension, Korea's all-important export engine.
While these developments augur a relatively sanguine outlook on Korean banks in the longer-term, we hold a less positive view on the banking sector in the near-term. The domestic real estate market is unlikely to witness any meaningful recovery in the quarters ahead and will consequently adversely impact banking profitability, given that mortgage loans comprise a significant portion of banks' total loan book. Additionally, given our expectations of further monetary easing, we expect banks' net interest margins to face further compression. Loan growth is expected to remain tepid on the back of a slowing economy and weak private consumption.