Key rate cut gives rise to profit fears

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Key rate cut gives rise to profit fears

The Bank of Korea’s rate cut to a historic low of 1.5 percent deepened worries about profitability losses at Korean banks and insurance companies.

The cut in the key policy rate would lead to a drop in interest rates, which will deal a blow to net interest margins, bankers said.

It usually takes a month to set interest rates.

The deteriorating profitability in banks’ net margins will force many Korean banks to expand their business abroad.

“While the growth of banks is in a slump due to many regulations from the government, we think the key policy rate would accelerate our losses in net interest margins,” said an employee of a major bank in Korea by phone. “We think the only way to escape this crisis is to expand business abroad, particularly in several Southeast Asian countries that offer higher interest rates.”

Insurance companies also expressed concerns over the rate cut, particularly life insurers that sold fixed-rate, long-term products in the 1990s.

When Korea was hit by the 1997-1998 Asian financial crisis, many Korean households rescinded their insurances. To make up the losses, many life insurance companies competed by overselling fixed-rate insurances, promising long-term interest rates of 7 to 8 percent - not much at the time, considering banks offered interest rates of up to 30 percent.

Under a low interest rate policy, the gap between insurance companies’ investment returns and guaranteed yield has widened, leading to a loss in their profitability.

“The average guaranteed yield of our entire products is about 5.5 percent and the investment returns’ yield is about 4 percent, generating a 1.5 percent of loss between them,” said an employee of a major life insurance company in Korea by phone.

“Under the low rate policy, many life insurance companies are trying to diversify their investment portfolio, not just on safe assets such as bonds or stocks but also investing on overseas properties.”

Eric Yau, an analyst at Moody’s, said the drop in profitability could lead insurers to make risky investments.

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