When Kakao Bank opened its digital doors in 2017, few expected that South Korea’s first online lender would stand shoulder to shoulder with the country’s traditional financial giants in just four years.
But the subsidiary of the country’s second-largest internet company Kakao filed an initial public offering with the financial regulator on June 28, seeking to raise up to KRW 2.6 trillion (USD 2.3 billion) on the benchmark Kospi stock market in August.
If the listing goes as hoped, Kakao Bank’s market cap may reach KRW 18.6 trillion won, vaulting it to No. 3 in the banking industry, following heavyweights KB Financial Group, which includes Kookmin Bank, at KRW 21.6 trillion and Shinhan Financial Group, of which Shinhan Bank is the core, at KRW 20.3 trillion.
Moreover, Kakao Bank is growing faster than its rivals and it is likely just a matter of time before the internet lender surpasses them. It said in March it had deposits of KRW 25.4 trillion and had lent out KRW 21.6 trillion, marking a compound annual growth rate, or CAGR, of 67.1% and 63.8%, respectively, far outpacing domestic lenders which saw increases of 9% and 8% during the same period.
Kakao Bank plans to use the funds raised from its IPO to invest KRW 350 billion for hiring, improving customer service, advancing credit evaluation models, expanding customer protection infrastructure, research and development “as well as acquiring fintech firms,” it said in a news release after filing the IPO registration. “In the mid to long term, we plan to reach the global market through joint ventures and other measures.”
Analysts say that the country’s traditional banks face mounting competition as Kakao ventures into multiple loan segments.
“Kakao Bank’s assets rose rapidly in unsecured personal lending by attracting the largest number of users among [South] Korea’s mobile banking apps through a seamless digital banking experience,” said Ok Tae-jong, a vice president and senior analyst at Moody’s Investors Service, in a report last week. “It has lower costs than most local bank peers in 2020, by using advances in technology and operating without physical branches.”
Ok said that the incumbents are at a competitive disadvantage against big tech companies as they lack platforms to attract customers and collect data from nonfinancial services. They also incur higher costs in maintaining physical branches, he said.
SK Securities also said that Kakao Bank benefits from low costs in human resources and branch management compared with its traditional rivals. Kakao had hired 952 employees as of March with assets per employee reaching KRW 30.1 billion, higher than the four major lenders’ average of KRW 27.1 billion.
“Kakao Bank could save costs in human resources compared to other commercial lenders, investing them in business infrastructure instead,” said Koo Kyung-hoe, an analyst at SK Securities.
South Korea has for years been noted for its tech-savvy population, something that clearly benefits Kakao Bank. Moody’s said that its mobile app had monthly active users in November last year of more than 10 million, or 21% of the country’s population above 15 years of age.
Also, the coronavirus pandemic pushed older people to embrace digital banking more than previously and to demand such services from traditional banks. Kakao Bank said that those aged 50 and over have increasingly signed up for the past year and account for 30% of new customers.
Kakao Bank’s emergence comes as South Korea’s overall banking industry has been consolidating over the last decade. Hana Bank merged with Korea Exchange Bank in 2015, after its parent Hana Financial Group acquired a 51% stake in KEB from Lone Star Funds for 3.9 trillion won in 2012.
Foreign lenders are also pulling out of the market due to tough competition with local institutions. Citibank is in talks with South Korean banks to sell its consumer banking unit in the country after the US giant in April announced a plan to focus on its key markets.
Traditional lenders say they well understand that strong platforms are a must to survive in competition with digital rivals.
“We know that we cannot survive if we are left behind in competition for a platform,” said a Kookmin Bank spokesperson, adding that it is working on various changes and will continue doing so. “It’s not a one-time event.”
He said that Kookmin changed its organizational structure to more quickly address market demand by putting bankers and technicians on the same team. The bank is also diversifying and improving its mobile offerings by launching a comprehensive app as well as simplifying an existing one for simple payments.
But analysts say that the shift by traditional banks to platform-based services, while ultimately offering savings down the road, are likely to require significant investment with smooth sailing far from guaranteed.
“Incumbents’ strategies to strengthen their platforms could involve additional costs and higher operational risks,” said Ok at Moody’s. “More fundamental adjustment risks are potential changes in these banks’ existing loan pricing and underwriting strategies, which could subject their asset quality, profitability and capital to greater uncertainty.”
Local lenders are also hedging risks by investing in their biggest online rival. Kookmin Bank owns a stake of 8.02% in Kakao Bank, making it the third-largest shareholder. Internet company Kakao, which boasts the popular messaging app KakaoTalk, is the No. 1 shareholder at 27.26%, followed by Korea Investment Value Asset Management, which holds 23.25%.
Kakao Bank, while the biggest, is not the only digital lender in town. K Bank, run by telecom company KT, is another. In September, a third digital bank Toss, will launch services targeting customers it sees as overlooked by traditional lenders such as students, homemakers, small-business owners, and non-Koreans.
But there are challenges ahead. Analysts say that the digital banks need to prove to investors that they are sustainable and profitable. K Bank, for example, posted an operating loss of 105.4 billion won last year, which widened from KRW 100.8 billion in red ink in 2019.
“The key issue to keep its value above the IPO price is whether Kakao Bank can establish its own business model by expanding its platform business and creating synergy effects in the Kakao ecosystem,” said Jun Bae-seung, an analyst at eBest Securities.
“In addition, developing its own credit evaluation model and improving risk management skills will be Kakao Bank’s next tasks as the lender expands its loan business to mid-tier customers,” Jun said.
Kakao Bank is betting it can successfully surf the country’s ongoing wave of IPOs this year, but risks have come to the fore, highlighted by game developer Krafton. It cut its IPO price by more than 10% earlier this month as South Korea’s financial regulator raised questions over its valuation and demanded a pricing redo, casting a shadow over the boom.
Kakao Pay, an online easy payment affiliate of Kakao, will also list next month, aiming to raise as much as KRW 1.6 trillion. Kakao Pay is expected to debut on the Kospi on Aug. 12, just one week after Kakao Bank.
Analysts say that Kakao’s aggressive IPO strategy undermines shareholder value. Kakao listed Kakao Games last year and plans to list Kakao Entertainment next year.
“We must emphasize its harm on existing shareholders and the market,” said Paul Choi, head of Korea research at CLSA. “The existing shareholders of the parent are left with a cashed-up holding company with a widening discount and little reason to own it now that the more exciting parts of its business can be owned directly.”
Such a view, however, is of no concern to Kakao.
“We don’t worry about Kakao’s corporate value after listing some of our communities,” CEO Yeo Min-soo said at the company’s earnings conference call in May, citing expected continued high revenue and operating profit growth led by KakaoTalk. “We will add future businesses in various sectors to our portfolio as well as continuously find new growth engines.”