South Korea has just three digital banks, but they are having an outsized impact on the country’s financial services sector. While South Korea is well banked, its traditional lenders are not digitally adroit, nor do they typically meet the needs of customers without top credit scores. These shortcomings have created an opportunity for neobanks including Kakao Bank, K bank and Toss to shake up the market, with positive implications for the overall financial services industry.

Regulators in South Korea have treaded carefully, only greenlighting digital banks after they met strict capitalization and ownership requirements. Similarly to Taiwan, South Korea did not want tech giants with limited experience in the financial sector to hold large majority stakes in any digital lenders. For instance, Kakao Bank, the most successful digital lender in South Korea, is owned by a consortium of more than 13 shareholders. The platform company Kakao Corp., Kakao Bank’s parent company, has a roughly 32% stake. The second largest shareholder is a local asset manager, Korean Investment Value Asset Management, which holds a 27% stake. Incumbent financial services firms are the three largest shareholders in K bank: BC Card, Woori Bank and NH Investment & Securities.

At the same time, South Korea’s Financial Services Commission has been proactive about encouraging fintech development. The regulator has balanced risk management with a focus on harnessing fintech’s positive attributes. Indeed, South Korea was ahead of the curve on digital banks, approving Kakao Bank and K bank to launch in 2017, well before neobank licenses were awarded in Hong Kong (2019), Taiwan (2019) and Singapore (2020). South Korea’s third online-only lender, Toss, was awarded a preliminary license December 2019 and applied for a digital bank operating license in February.

“Fintech is one of the key areas actively promoted by the Korean government for innovation-led growth strategy,” the Financial Services Commission says on its official website. “The emergence of innovative financial solutions in Korea has improved consumer experience while prompting further innovation and competition in the financial sector.”

That’s not just sloganeering. Both Kakao and Toss have developed sleek apps that offer users a bevy of financial services under the same roof. To be sure, the coronavirus pandemic has accelerated digitization of the financial sector in Korea (and everywhere else in the world), but that is not the main reason for the ascendancy of online banking in the country. Rather, it is the convenience and quality of the services, which benefit from South Korea’s world-leading internet connection speed (roughly triple the global average) and high smartphone penetration rate of 95%.

Boosting financial inclusion and innovation

Kakao’s investment products are proving successful. To foray into this market segment, the company took a 60% stake in Baro Investment & Securities in February 2020. Shortly thereafter, it launched the digital brokerage Kakao Pay Securities, one of the first platforms of its kind in Korea. One of its most popular products, which is aimed at the youth market, lets users put leftover change in exchange-traded funds (ETFs).

The platform should be especially beneficial for newbie investors or those with limited assets given its “ease of use, strong connectivity and technology,” a spokesperson told The Korea Times, adding that Kakao Pay Securities “allows them to easily enter into the financial market and to expect profits from various products with a smaller amount of money.”

For its part, Toss has already developed about 40 services covering payments, financial dashboard, credit score management and more. It recently acquired a securities brokerage license and plans to launch a brokerage unit this year – Toss Securities – targeting users of its app in their 20s and 30s, which account for about 10 million of its 18 million users.

“We have designed our mobile trading platform and organized major services from beginning investors’ perspectives. Toss Securities will be an alternative investment platform for them,” Toss Securities CEO Park Jae-min said in a statement.

Once it can serve as a licensed digital bank, Toss will be able to take deposits and offer loans.

The company sees a big opportunity in South Korea's mid interest range loan market, where it believes it can crunch user data to lower delinquency rates for subprime credit lending. Toss Bank also plans to offer customers bespoke product recommendations from banks, insurance and securities companies based on its analysis of user data.

“We are building a financial super app fundamentally innovating across every facet of consumer finance," SG Lee, co-founder and CEO of Toss’s parent company Viva Republica, said in a statement.

Given its capitalization travails, K bank has taken a slightly different route than Kakao or Toss. In April 2019, K bank suspended most of its services as it was unable to meet Korea’s capitalization requirements for digital lenders. This had more to do with antitrust violations by one of its then major shareholders than a problem with the company’s business model. 

K bank eventually managed to raise enough funds to resume operations and has sought to bring customers onboard quickly by offering cryptocurrency trading services. Under a deal K bank struck with crypto exchange Upbit in June 2020, retail investors who want to trade crypto with Upbit must do so through K bank. Since March 2020, Korea has required exchanges to work with licensed financial institutions to ensure the use of valid, real-name accounts for trading. 

Amid the bitcoin boom, K bank’s popularity is surging. K bank's deposits reached 4.5 trillion won ($4.02 billion) by the end of January, adding a record 750 billion won in just a month's time. The neobank signed up 920,000 new accounts in January and February alone.

A virtuous cycle

Among South Korea’s three virtual banks, Kakao is profitable, Toss broke even in the second quarter of 2020 and K bank is still in the red. However, if it maintains its current growth rate, K bank could break even relatively soon. Prospects look good for all three of the digital lenders.

Kakao Bank has decided that the time is right to go public. The company reached profitability after just two years and performed exceptionally well in 2020, recording a net profit of 113.6 billion won ($102 million), up 800% year-on-year. In April, Kakao Bank applied for preliminary approval for an IPO, according to Korea Exchange. The IPO is likely to happen in the third quarter of the year. Analysts reckon the neobank’s valuation is roughly 10 trillion won.

Crucially, Kakao Bank has chosen a sustainable business model that does not rely on gimmicks to lure customers. Its innovative online banking products have been a hit with retail customers. It has been able to attract customers easily thanks to the strength of the Kakao ecosystem. Many Koreans who bank with Kakao first became familiar with the company through its popular Kakao Talk messaging app, which has 45 million users in the country, roughly 87% of the population.

Kakao Bank is “expected to reach its target deposit size with relatively little use of high-interest bait products ... (and) in the longer term raise its loan market share,” Jeong Tae-joon, an analyst at Yuanta Securities Korea, told Reuters in April.

Provided that K bank’s crypto-heavy strategy is successful, it could go public as early as 2022. While the focus on digital currency has certain risks, it may well pay off. 2021 increasingly looks like an inflection point for crypto – the year that it finally crosses over to the mainstream financial industry.

Meanwhile, given the success of Korea’s neobanks, its traditional banks are mulling launching their own online-only banks. The combined annual net profit of 10 Korean banking groups in 2020 fell 0.8% to 15.1 trillion won, according to the Financial Supervisory Service (FSS).

According to The Korea Herald, the Korea Federation of Banks, an organization that represents South Korea’s commercial lenders, recently received a joint message from the largest Korean banking groups (including KB, Shinhan, Hana, Woori and NH) expressing their intention to launch neobanks if regulators give their consent.

In the short term, traditional Korean lenders may struggle to compete with the digital upstarts, but in the long term, the increased competition will force them to innovate. This will improve the quality of their services, a boon for their customers.

For Taiwan, which is just beginning its digital banking journey, Korea’s experience is instructive. Strict regulation is important, but digital banks must be given room to grow sustainably. When they are, the overall financial services sector benefits, from customers to incumbent banks (as they are pressured to innovate) to capital markets, not just the neobanks.

While Taiwan is overbanked in the sense of having 37 retail banks, consolidation might occur more rapidly amid strong competition from digital lenders. Ultimately, market forces must be permitted to prevail.