ELS-related losses to reduce Koreans’ operating profits by up to 34%: Fitch

Banks are believed to have accounted for 82% of $14.4b in ELS sales in 2023.

The recent equity-linked security (ELS) scandal involving 11 South Korean banks will likely weaken their earnings and profitability, says Fitch Ratings.

On March 13, Korea’s Financial Supervisory Service (FSS) issued compensation guidance following an investigation into banks and brokers’ sale of ELS linked to the Hang Seng China Enterprises (HSCE) index.

Fitch estimates compensating the losses could reduce operating profit by 6%-34% in 2024, with the ratio of operating profit to risk-weighted assets for the major banks dropping by 3 basis points (bp) to 47 bp.

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Banks are believed to have accounted for 82% of the US$14.4b (KRW18.8t) in outstanding ELS sales as at end-2023. Notably, Kookmin Bank is said to have accounted for more than half of ELS sales in 2023. Shinhan Bank, NongHyup Bank, and KEB Hana Bank are believed to account for around 13%-16% of bank sales each.

Other banks with a notable share in 2023 ELS sales are Standard Chartered Korea, said to account for 8%; and Woori Bank, with less than 1%. 

The FSS’ proposed calibrated compensation system pushes for higher indemnification where banks adopted more aggressive internal sales targets for the scheme with a lack of appropriate suitability assessments; and lower compensation where investors made repeat investments, noted Fitch.

“We believe banks are likely to tighten operating standards in the wake of the ELS selling investigation, which will weigh on fee income. Earnings and profitability are already a weaker aspect of standalone credit profiles for most Korean banks,” Fitch Ratings said.

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The ratings agency further expects the major banks’ net interest margins to decline modestly in 2024, assuming 50 bp policy rate cuts in 2H24. 

“Loss compensation ratios could be subject to extended litigation and may be determined case by case. This could limit any impact on earnings and spread it over several years,” Fitch noted.