This is due to lower impairment expenses, stable net interest margins, and sluggish loan growth that will support higher earnings, says Moody’s.
Moody's Investors Service says that the outlook for Korea's banking system is stable over the next 12 to18 months, based on the expectation of sustained economic growth and a modest improvement in the sector's financial metrics.
Lower impairment expenses -- combined with stable net interest margins -- will support higher earnings.
At the same time, sluggish loan growth prospects will result in further improvements in the already strong capital ratios and lead to continued reductions in the loan to deposit ratios of Korean banks.
While asset quality should be improving, weaknesses remain in the key sectors of concern to Korean banks -- real estate project finance loans, construction, shipbuilding and shipping.
"Additionally, a key credit issue facing the system is high and rising consumer leverage," says Youngil Choi, a Moody's Vice President and Senior Analyst.
"We believe that Korea's household debt to disposable income is one of the highest globally, and it continues to rise."
"Moreover, a high proportion of this household debt burden consists of interest-only, floating-rate mortgages which means that there is little natural amortization of the debt burden as loans season, and servicing costs increase with interest rate rises," he adds.
The banks' willingness to roll over these loans at maturity (which Moody's expects to continue during this outlook period) means that there is no clear trigger for these loans becoming non-performing.
"But it also means that the problem of high consumer leverage is unlikely to ease within the foreseeable future," adds Choi.
Another key issue is the uncertainty about the future ownership of the three major banks in the system: Woori Bank, Korea Development Bank and Korea Exchange Bank.
The lack of clarity about the future of the industry's make-up and the extent of long-term government control over important segments of the banking system creates uncertainties regarding the competitive dynamics and long-term profitability prospects of the banks.
Foreign currency liquidity is yet another issue. Korean banks rely heavily on market funding amid the lack of a stable foreign-currency deposit base, which exposes them to refinancing risks in the event of a capital market freeze.
While the issues may not become major ones for the banks in the next 12 to 18 months, Moody's does not feel it is appropriate to signal a positive outlook as long as they exist as challenges to the long-term health of the banking system.
The stable system outlook is consistent with the stable outlook for the standalone Bank Financial Strength Ratings (BFSR) and long-term deposit and debt ratings for most of the Korean banks.
Moody's rates 17 banks in Korea, which together account for about 99% of the system's total assets. Their average (asset-weighted) bank financial strength rating is C-, mapping to Baa1 on Moody's traditional long-term rating scale.
The extensive Moody's report covers a wide range of themes, including the key drivers behind the stable outlook, key system performance measures, asset quality and capital, and funding and liquidity.
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