Download Overseas Expansion of Korean Financial Services Institutions

Financial Services Industry
Overseas Expansion of Korean Financial
Services Institutions
Bosung Shin, Research Fellow* Evidence is emerging from all corners that the growth of the Korean financial market
has reached a saturation point. For a breakthrough, Korean financial institutions
must look overseas, but they have to decide which region to target. One of the main
criteria to set the target should be countries where the economy is growing fast but
whose financial markets are underdeveloped. Korean firms will find opportunities
in areas where there is large demand for financial services to support economic
growth, but where domestic financial institutions cannot supply the demand.
Fortunately, the neighboring Asian countries meet these criteria. Korean financial
institutions thus must aggressively develop foreign expansion strategies to enter
into this region.
I. Drivers of Overseas Expansion of Financial Services
Institutions
1. Necessity for overseas expansion
To begin, we look at the domestic market conditions, or push factors, that necessitate
foreign expansion by Korean financial services institutions.
A. Saturation of the domestic market
The first factor that is driving Korean financial firms to overseas expansion is that
the Korean financial market has reached its growth limits. This can be seen clearly
* All opinions expressed in this paper represent the author’s personal views and thus should not be interpreted
as the Korea Capital Market Institute’s official position.
Tel: 02-3771-0651, E-mail: [email protected]
7
Capital Market PERSPECTIVE
when looking at the growth rate of financial services customers. First, the number of
deposit accounts of commercial banks has remained flat since the beginning of the
2000s. Also, the share of households investing in equity has stagnated. Furthermore,
after an initial period of a rapid increase, the number of funds held by households
has recently begun to decline (Figure 1). In addition, the insurance penetration rate of
Korea is one of the highest in the world, implying that customer base expansion will
be a challenging task (Figure 2).
Figure 1. Number of clients/accounts in each financial sector
Number of deposit accounts in
depository banks
The number of population holding
stocks to the total population
(Unit: 1 million accounts)
(Unit: %)
200
25
Number of mutual fund accounts
held by households
(Unit: 1 million accounts)
10
The ratio to the economically active population
The ratio to the total population
20
150
18.5
19.1
7.8
8
7.4
7.2
6.2
15
6
15.1
100
9.2
10
9.6
4
2.5
50
5
0
7.0
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
2
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
2004
2005
2006
Note: The ratio of stock investors to the total population
Source: Bank of Korea, Korea Exchange, OECD
Figure 2. Insurance penetration of Korea vs. the OECD average
(Unit: %)
20
Korea
15
OECD
13.8
10.9
10
8.4
8.6
5
0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Note: Insurance penetration: Insurance premium/GDP
Source: Financial Supervisory Service (FSS), OECD
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2007
2008
Overseas Expansion of Korean Financial Services Institutions
A common consequence of market saturation is increased competition which leads
to the decline of profitability. Korea is not an exception to this rule, as the bottom lines
of financial companies have seen systematic and sustained declines across all financial
sectors (Figure 3). The net interest margin (NIM) for commercial banks, which stood
at 3% in 2005, has declined every year and was 2% in 2009.The fact that their return
on equity (ROE) ratios has been trending downwards across all financial industries is
another indicator of intensifying competition.1)
Figure 3. Profitability of Korea’s financial sectors
Return on Equity
Banks’ Net Interest Margin
(Unit: %)
(Unit: %)
30
5
bank
securities
insurance
20
4
3
2.8
2.6
2.4
2.3
2.0
2
10
1
0
0
FY2005
FY2006
FY2007
FY2008
FY2009
FY2005
FY2006
FY2007
FY2008
FY2009
Source: FSS
For financial firms, there are two avenues to mitigate the circumstances of escalating
competition and declining profitability. One is to look for solutions within the domestic
market and the other is to develop opportunities abroad.
For the former option, the easiest way to face competition and falling profits is to
remove the source of competition. This can be done through mergers or acquisitions
of competing firms, which will intensify market concentration. By using the increased
market power, the acquiring firm will be able to improve margins. But the current
market structure is not conducive to this approach. The combined market share of
the top 5 commercial banks is well over 80% and the situation is not very different
in the insurance industry. As excessive market concentration and its negative effects
1) The reason for the high ROE in the life insurance sector in FY2009 was the increase in investment returns
from falling interest rates and the short term recovery of the stock markets.
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Capital Market PERSPECTIVE
are already a concern, trying to gain increased market share through mergers and
acquisitions is not feasible.2) Ultimately, the only realistic solution is to find opportunities
for growth beyond the domestic market. Schoenmaker and Van Lacke (2007) have
shown empirically that the higher the domestic market concentration, the faster the
rate of overseas expansion by commercial banks.
Figure 4. Market concentration of Korea’s financial sectors (2009)
CR5
HHI
(Unit: %)
100
2,000
83.5
1,628
80
1,500
60.8
60
1,177
1,000
46.7
40
635
500
20
0
0
bank
securities
insurance
bank
securities
insurance
Source: FSS
B. Economic slowdown and demographic changes
Since 2000, Korea’s GDP growth has remained below 5%, indicating that the country
has structurally entered the low growth phase of economic development (Figure 5). To
make matters worse, Korea’s population growth is stagnant because its birth rate is one
of the world’s lowest. This will result in a declining working age population and drag
future economic growth (Figure 6).
As the Korean economy enters the mature growth phase, the need for domestic
financial companies to succeed overseas becomes even more critical. By enabling
domestic investors to access high growth countries, the overseas entry of financial
firms can help alleviate the problem of Korea’s low economic growth.
2) The level of market concentration is far less among securities firms. However, this is more a consequence of
the small size of the domestic capital markets not providing sufficient incentives for economies of size. From
this perspective, domestic securities firms need just as much to grow in size and expand abroad.
10 2010 Vol. 2, No. 4
Overseas Expansion of Korean Financial Services Institutions
Figure 5. GDP growth
(Unit: annual growth rate in %)
10
Korea
OECD
8
6
4
2
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
Source: World Bank DB
Figure 6. Population growth and birth rate
population growth
birth rate per a thousand people
(Unit: annual growth rate in %)
(Unit: %)
1.0
15
0.8
13
0.6
11
0.4
0.2
9
Korea
Korea
OECD
OECD
7
0
2000 2001 2002 2003 2004 2005 2006 2007 2008
2000 2001 2002 2003 2004 2005 2006 2007 2008
In addition, Korea is the world’s fastest aging society (Figure 7), and fiscal pressures
to support the increasing number of senior citizens are growing. The foreign expansion
of financial firms can also help reduce the fiscal burden, albeit partially, because it
provides better access to higher returns on investments.
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Capital Market PERSPECTIVE
Figure 7. Speed of aging: The growth rate of the population over 65 years old
(Unit: %)
10
Korea
OECD
8
6
4
2
0
2001
2002
2003
2004
2005
2006
2007
2008
Source: World Bank DB
C. Level of internationalization of domestic financial institutions
Despite the various motives for Korean financial firms to go abroad, the current state
of internationalization of these institutions leaves a lot to be desired. Figure 8 shows
that overseas assets of domestic banks accounted for a mere 4.2% in 2009. The situation
is not much different for their net income, among which only 5.3% is generated from
overseas.
The fact that Korean banks lag behind in overseas expansion is even more evident
when measured against global players. For instance, Deutsche Bank generated 71%
of its net income from abroad as of FY2009 (Figure 9), compared to around 5% for all
Korean banks.
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Overseas Expansion of Korean Financial Services Institutions
Figure 8. The ratio of overseas assets (revenue) to total assets (revenue) in Korean banks
(Unit: %)
10
Overseas assets/total assets
Overseas revenue/total revenue
8
6
5.3
4
4.2
3.0
2
2.5
0
2005
2006
2007
2008
2009
Source: FSS
Figure 9. The ratio of overseas revenue to total revenue in world-leading banks (2009)
(Unit: %)
100
80
71.4
60
51.1
44.0
40
24.5
19.1
20
5.3
0
Deutsche
Bank
Citigroup
Goldman
Sachs
JPMorgan
Chase
Morgan
Stanley
Korea’s
banks
Source: Annual reports
2. Criteria for choosing a destination for overseas expansion
A saturated domestic market, high levels of accumulated domestic assets, low
economic growth, and a rapidly aging population are all key drivers of foreign
expansion and the reasons why domestic financial companies must improve their
unimpressive level of overseas market participation. But the question is where to go,
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Capital Market PERSPECTIVE
meaning which region and countries offer the most attractive opportunities. To answer
this question we must look at the key criteria, or pull factors, to determine candidate
markets for overseas expansion.
The first is market size. The bigger the market size, the larger the potential customer
base, as well as the space to implement diverse business strategies. The importance of
market size in an overseas market entry decision is a natural consideration (Claessens
et al, 2000; Brealey and Kaplanis, 1996; Buch, 2000). Measures of market size include
GDP, population, land area, urbanization, and natural resources.
The second of the criteria is the economic growth rate. An early entry into a small
but fast-growing market will increase opportunities to acquire a large market share
when the market does become sizable (Focarelli and Pozzolo, 2005). Measures of growth
rates of economies include the GDP growth rate, population growth rate, urbanization
speed, and industrialization rate.
Another important factor is geographic proximity. The greater the geographic
proximity, the easier it is for resource allocation and control. There is empirical
evidence that overseas expansion of a financial firm is concentrated in geographically
close regions (Berger and DeYoung, 2006, Berger et al., 2001).
Last, for overseas expansions of financial firms to be effective, the target country
should have a gap between the development level of the real economy and the
financial sector (Goldberg and Grosse, 1994; Grosse and Goldberg, 1991). This means
that a desirable target country should have a fast-growing economy and a relatively
underdeveloped financial sector. It is in such places where the supply of credit is
insufficient to meet demand, and Korean financial firms will find opportunities to
actively participate. Measures of disparity between the real economy and the financial
sector include the ratio of commercial bank loans to GDP and the ratio of market
capitalization to GDP.
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Overseas Expansion of Korean Financial Services Institutions
II. Attractive Entry Region: Asia
Here, we provide evidence that the major Asian countries are the most appropriate
markets for Korean financial firms to enter. Asia has the most attractive conditions in
terms of market size, growth rate, geographic proximity, and gap between the real and
financial economy.
1. Market selection criteria
With many rapidly growing countries, Asia is naturally one of the most appealing
regions for entry by foreign firms. However, within Asia, economies such as Japan,
Australia, and Hong Kong are already well developed and have more advanced
financial markets than Korea. This implies that the financial needs of these countries
are met sufficiently within the domestic market and that there is little room left for
Korean firms in these nations. Thus, countries with advanced economies should be
omitted from the list of overseas expansion candidates. Also, those countries that are
too small in market size or politically unstable should be excluded as well.
Based on the above criteria, we choose 15 target candidates including China,
Thailand, Vietnam, Indonesia, India, Malaysia, 6 GCC countries (Bahrain, Kuwait,
Oman, Qatar, Saudi Arabia, UAE), Uzbekistan, Kazakhstan, and Turkey. Then, we
attempt to examine the 15 nations’ potential as destinations for overseas expansion.
2. Growth potential
In 2008, the combined GDP of the 15 target countries was small compared to that
of the world or the OECD, but their growth rates were significantly higher (Figure 10).
Such fast growth rates imply large demand for financial services which is necessary to
back up economic growth. This is one of the factors that work favorably for the entry of
Korean financial firms in these markets.
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Capital Market PERSPECTIVE
Figure 10. GDP and GDP growth (2008)
GDP
GDP growth
(Unit: $ billion)
(Unit: annual growth rate in %)
50,000
10
40,232
40,000
8
30,333
30,000
6
20,000
5.3
4
10,000
2.0
2
1.1
4,743
0
Target
World
0
OECD
Target
World
OECD
Source: World Bank DB
In 2007, the ratio of gross fixed capital formation (GFCF) to GDP of the 15 target
countries stood at 26.8%, which was around 5% higher than the global average of 21.7%
and the OECD average of 22.5%. Especially, the growth rate of GFCF in the target
countries was 13.9%, significantly higher than the world’s growth rate of 4.5% and
5.5% of the OECD. This reflects the fact that new investments in these countries are
taking place at a rapid pace, which will lead to increased demand for financial services
overall (Figure 11).
Figure 11. GFCF and its growth
GFCF/GDP
GFCF growth
(Unit: %)
(Unit: annual growth rate in%)
50
15
40
12
30
13.9
9
26.8
21.7
22.5
20
6
5.2
4.5
10
0
3
Target
World
OECD
0
Target
World
OECD
Note: GFCF to GDP excludes Oman. GFCF to GDP growth rate excludes Kuwait, Oman, Qatar, and Turkey.
Source: World Bank DB
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Overseas Expansion of Korean Financial Services Institutions
Asia’s attractiveness also dominates in terms of demographic factors. Population
size is an important factor both as a key input of economic production and as the
basis of market demand. In 2008, the population of the 15 target countries was 3
billion, representing 45% of the world population. Not only is population high in these
countries, but the rate of population growth is very high, making it likely that attractive
markets will come into shape (Figure 12).
Figure 12. Total population and its growth (2008)
Total population
Population growth
(Unit: billion persons)
(Unit: annual growth rate in %)
10
3
8
2.3
6.7
2
6
4
1.2
3.0
1
2
0
0.8
1.2
Target
World
OECD
0
Target
World
OECD
Source: World Bank DB
Rapid urbanization raises the demand for social overhead capital, energy, and real
estate, which in turn increases demand for financial services. In addition, the expansion
of the middle class associated with urbanization increases demand for private financial
services, such as mortgage financing. Figure 13 shows that the target countries’ urban
population growth rate is 3 times that of the OECD, indicating that the demand base of
financial services is expanding rapidly.
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Capital Market PERSPECTIVE
Figure 13. Urban population growth (2008)
(Unit: annual growth rate in %)
5
4
3
3.0
2.0
2
1.0
1
0
Target
World
OECD
Source: World Bank DB
3. Socioeconomic similarities
Korea’s economy is closely knitted with the major Asian economies, and such
interrelatedness can facilitate Korean firms’ entry into these countries. A measure
of the relatedness between countries is how actively companies of one country are
operating in the market of the other country. In this regard, Asia is quite attractive as
the share of major Asian nations for overseas expansion by Korean firms increased
from 43.3% in 2000 to 49.5% in 2008 (Figure 14). Thus, about half of foreign entry by
Korean firms is taking place in Asia.
The interrelation of Korea with major Asian economies can also be seen in trade
volumes and foreign direct investments. In Figure 15, it can be seen that Asia’s share of
Korea’s total trade volume continues to increase. As a result, in 2008, Asia represented
35.1% of Korea’s exports and 45.5% of its imports. The figures for foreign direct
investment are even stronger. In 2008, over 90% of Korea’s foreign direct investments
were within Asia.
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Overseas Expansion of Korean Financial Services Institutions
Figure 14. Fifteen Asian countries’ share in the total number of overseas expansion
by Korean firms
(Unit: %)
50
49.5
48
46
44
43.3
42
40
2005
2006
Source: The Export-Import Bank of Korea DB
Figure 15. Trade with and FDI to Asian countries
Korea’s FDI Asian countries/
Korea’s total outbound FDI
Trade with Asian countries
(Unit: %)
10,000
Export
80
Import
8,000
60
40
41.0
41.1
31.7
34.1
2006
2007
100
The amount of FDI (LHS)
The share of Asian
countries (RHS)
80
6,000
60
4,000
40
2,000
20
45.4
35.1
20
0
(Unit: %)
(Unit: $ million)
100
2008
0
2006
2007
2008
0
Source: The Export-Import Bank of Korea DB
Finally, we look at proximity in terms of the number of Korean residents living
abroad. Figure 16 shows the total number of Koreans abroad and the share of the target
countries. As can be seen from the figure, the target countries account for close to half
of the total Koreans living abroad. A large share of the Korean population in the target
market encourages trade activities, thus making it easier for Korean firms to enter the
region. This is another important factor for foreign expansion.
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Figure 16. Korean residents in Asia/Total overseas Korean residents
(Unit: 1 million persons)
(Unit: %)
10
100
Number of overseas Korean residents (LHS)
Asia’s share in overseas Korean residents (RHS)
8
80
6
60
4
40
2
20
0
0
2006
2007
2008
2009
2010
Source: Ministry of Foreign Affairs and Trade DB
4. The Gap between the real and financial economy
The target countries in Asia are attractive for Korean financial firms from the
perspective of growth potential and proximity. Next, we examine whether these
countries are qualified for the last criterion for entry, the gap between the real and
financial economy.
Figure 17. Private sector loans to GDP
(Unit: %)
120
112.6
100
80
60
57.8
59.3
40
20
0
Target
World
OECD
Note: The figures are for 2008. Private sector loans to GDP include banks and all other financial institutions.
Source: World Bank DB
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Overseas Expansion of Korean Financial Services Institutions
First, in looking at the development of the banking sector relative to the economy,
we see that the private sector loans to GDP for the target countries is only half that
of the OECD level (Figure 17). This implies that the supply of credit is insufficient to
support the growth of the real economy in these countries.
The situation is similar when looking at the ratio of bank deposits to GDP. In Figure
18, this ratio is 57.7% for the target countries, substantially lower than the OECD average
of 91.6%. This implies that the flow of credit is not sufficient to fully support economic
growth due to a lack of financial asset accumulation.
Figure 18. Bank deposit to GDP
(Unit: %)
100
91.6
80
60
57.7
59.3
40
20
0
Target
World
OECD
Note: The figures are for 2008, and China, Bahrain, Qatar, UAE, and Uzbekistan are excluded from the data.
Source: World Bank DB
The development of capital markets, the other pillar of the financial sector, in the
target economies is also lagging. First, the number of listed companies in the target
countries is only one third of that of the OECD average (Figure 19). The size of the capital
markets is also relatively small. Especially, the bond market of the target countries is
only half of the OECD average (Figure 20).
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Capital Market PERSPECTIVE
Figure 19. Number of listed companies
(Unit: Number of companies)
60,000
48,904
50,000
40,000
30,000
27,487
20,000
9,542
10,000
0
Target
World
OECD
Source: World Bank DB
Figure 20. Capital market size
Market capitalization (aggregate value of
listed stock) to GDP
Total bond outstanding to GDP
(Unit: %)
(Unit: %)
150
100
89.0
120
112.6
94.0
90
89.6
79.7
80
60
46.6
60
40
30
20
0
Target
World
OECD
0
Target
World
OECD
Note: The figures are for 2008. Market capitalization to GDP includes Thailand, India, Indonesia, Malaysia,
Saudi Arabia, Kazakhstan, and Turkey. Bond market to GDO includes China, Thailand, India, Indonesia,
Malaysia, and Turkey.
Source: World Bank DB
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Overseas Expansion of Korean Financial Services Institutions
III. Conclusion and Implications
Based on our examination, some Asian countries are appropriate destinations for
overseas expansion by Korean financial services companies. Compared to the OECD
averages, these countries combined have 5 times the economic growth rate and 3 times
the population growth rate, along with faster rates of urbanization. These are some of
the key factors that will ensure the development of the Asian region into a huge market
in the future.
On the other hand, the development of the financial sector of these countries is
lagging compared to the real economy. The banking sector is underdeveloped, with
bank assets to GDP at only half of the OECD average, and the capital markets are even
further behind. This implies that there are ample opportunities for Korean firms to fill
the gap in the financial sector. Moreover, Asia offers advantages for Korean firms in
terms of cultural proximity, which is an important consideration when taking the first
step into a foreign market.
Conditions are ripe for overseas entry of Korean financial firms. For a while, the
global expansion of financial institutions in developed countries will be slowed because
of the recent financial crisis. Also, attractive acquisition targets are likely to surface as
a depressed global economy leads to the emergence of distressed financial institutions
in some Asian countries. Given these circumstances, Korean financial firms should not
miss out the opportunities that will present themselves in the next few years.
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Capital Market PERSPECTIVE
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