(The following was released by the rating agency)
SEOUL/LONDON/SINGAPORE, July 25 (Fitch) A growing focus on consumer protection in Korea has increased legal and reputational risks for banks, and will weigh on the long-term profitability of the sector, Fitch Ratings says.
In the most recent example of this trend, The Board of Audit and Inspection of Korea said Monday that the banking system received KRW20.4trn (USD17.8bn) of additional interest income by increasing spreads on lending rates from October 2008 to December 2011. The authority did say that some of the additional income may have been "fair", but we believe this creates a potential for class action lawsuits by the borrowers.
Social and political concerns over the pricing of financial products and services have contributed to several other recent investigations and rule changes that enhance consumer protection in Korea. We expect this trend to increase rapidly if and when the pending Financial Consumer Protection Act becomes enacted. The Act will promote consumers' rights by, for example, increasing the liability of financial product sellers and by alleviating the burden of going through a conciliation procedure for small claims.
It is difficult to ascertain the financial implications for the system and individual banks at this stage, particularly as legal risks usually take a long time to materialise and the impact of rule changes on profitability is still unclear. These risks are negative for banks' credit profiles, but we also expect that such challenges to the banking system will ultimately help it to become more robust by strengthening internal controls and compliance functions.
Other examples of the increasing focus on consumer protection include an investigation into potential collusion on certificates of deposit (CD) rates. Korea's Fair Trade Commission said this month it has been investigating whether financial institutions have colluded on the 91-day CD rate which has been the benchmark rate for most floating-rate loans and derivatives in Korea. If the banks are found to have been involved in the collusion, we would expect legal actions against them to follow.
Mortgage lenders are facing class action lawsuits following the Supreme Court's decision in August 2011 that fees related to mortgages should be borne by the lenders. These fees amount to around 60bp of the total loan; and some households, assisted by the Korea Consumer Agency, are seeking reimbursement of the fees on mortgages originated since the beginning of 2003.
Credit card companies are also now prohibited from charging unduly high fees to small merchants following a February revision of the Specialised Credit Financial Business Act. The regulator has set the fee rate for weak merchants at 1.5%, down from 1.8%. Consequently, the credit card operators are under pressure to lower the average merchant fee rates by 24bp while maintaining cardholders' benefits.