Assessing the implications of rising delinquency rates at Korean digibanks

Written by Kapronasia || October 26 2023

South Korea’s three digibanks have been unusually successful given the high rate of failure, or at least underperformance, in this segment of financial services. The reasons for their success are many, from innovative business models to the weak digital offerings of incumbents, but support from regulators has also been crucial. We will now find out just how much confidence regulators have in these upstarts as they face rising delinquency rates that are a natural result of their focus on non-top tier borrowers.

South Korean media has described the delinquency rates at the country’s three digital banks of Kakao Bank, K Bank and Toss Bank as “alarming,” citing the increase in the average rate from 0.3% in 2021 to 1.2% by the end of August. But this number is not especially high. For instance, in the U.S. in the second quarter, the delinquency rate for all loans from commercial banks was also roughly 1.2%, according to the Federal Reserve Bank of St. Louis.However, if we look at the delinquency rate for what South Korea calls “medium to low credit score loans,” then the numbers are slightly more concerning. The average is 2.8%, up from 0.84% a year ago. While just 1.7% of these loans at Kakao Bank are delinquent, that number jumps to 3.4% at Toss Bank and 4.1% at K Bank.

That K Bank has the biggest problem with delinquent debt of the three is not all that surprising. After all, this is the bank that not long ago had to suspend some of its services for a while due to capitalization and other problems, and that then chose to rely on cryptocurrency to grow its deposit base. Being South Korea’s de facto “crypto bank” could entail certain risks, especially with almost 18% of its 3.1 trillion won (US$2.3 billion) in deposits made up of customer deposits from coin exchange Upbit.  

Some Korean lawmakers are concerned that K Bank could become overly focused on virtual assets and that certain risks could arise if the digital lender used Upbit deposits as a lending source. To be sure, Korean law requires virtual asset service providers to manage customer deposits separately from their own assets, but there are still loopholes because guidelines for deposit management are not detailed. For instance, according to Korean media, K Bank keeps exchange deposits in a corporate account, funds of which can technically be used for customer loans.

That said, Korean digibanks have sought to nip the problem in the bud by doubling their provisions for loan losses compared to the previous year. K Bank had 20 billion won in deposit reserves as of the end of September, while Kakao had 7.3 billion won, according to Maeil Business News Korea.

However, concerns persist, as high interest rates are expected to continue, potentially leading to further defaults among vulnerable borrowers.

We reckon that as long as provisions for loan losses are adequate, that South Korean digibanks can manage this delinquency issue. The fact is that they exist in part to serve an underserved demographic among the population that needs access to credit. Part of the trade-off for boosting financial inclusion in this case is accepting slightly more risk among certain borrowers.