Advent of Direct Banking
Direct banking means offering banking service remotely via online and telephone banking. With the advent of online banking technology in the early 1990s, several direct banks started to be created. The first bank adopted the concept of direct banking is First Direct in the United Kingdom, which was established based on the concept of telephone banking in 1989. In 1995, the first internet based bank, SFNB, was established in the United States. SFNB demonstrated the concept of direct banking could work and the concept was widely adopted as a method of entering banking industry among many non-banking financial institutions, such as E-trade Bank(security) and American Express Card(credit card). (1)
HSBC was the first bank which adopted the concept of direct banking in Korea. In 2007, HSBC launched direct banking service. However, because of limited area of service coverage and inconvenient deposit and withdrawal system, their service did not gain popularity. Finally, HSBC decided to withdraw from Korean retail banking industry in 2013.
Turning weakness into strength: KDB’s strategy for retail banking
At the late 2000, Korean government decided to privatize KDB, one of the largest bank in Korea. However, despite their strength in investment banking and corporate banking, many people questioned KDB’s compatibility as a commercial bank because of their financing ability. As a government owned bank, KDB heavily relied on the issuance of Industrial Finance Bond which was guaranteed by Korean government. Privatization means government would not guarantee the repayment of Industrial Finance Bond anymore. Therefore, KDB should have found a new way to finance capital.
The easiest and cheapest way of financing was increasing customer deposit. However, with small number of branches and limited experience in retail banking, competing in the realm of severely competitive retail banking industry was not an easy option for KDB. At 2011, while Korea’s major commercial banks had more than 1,000 operating branches, KDB had less than 50 branches. (2)
To overcome their weakness, at 2011, KDB decided to launch KDBdirect, new checking and savings product which offered high interest rate and visiting service to customers. KDB’s strategy was simple; returning back the potential operating expense of running too many branches to customers
Technology development in the IT industry made launching of KDBdirect possible. Widespread adoption of Internet enabled customers to be familiar with the concept of direct banking. Furthermore, technological advance in the mobile platforms made it possible to confirming customer’s identity in the remoted places besides branches, which was required process by law to initiate banking transaction in Korea. Therefore, with less than 50 branches and hundreds of newly hired travelling tellers, KDB were able to provide remote banking service to people in most of Korea’s urban area.
Thanks to high interest rate and convenient service, KDBdirect became hugely popular. Within 3 month after the launching of new checking and savings product, KDB attracted 150thousand new customers and collected amount of USD 6billion deposit. Other commercial banks reported KDB to the Financial Supervisory Service of Korea for the possibility of negative spread of their new product. However, after inspection, Financial Supervisory Service confirmed that KDBdirect did not have negative spread because KDB had earned profit with their new product thanks to their savings on operating expense; not having excessive branches enabled KDB to offer higher interest rate without jeopardizing their profit. (3) Finally, KDB turned their weakness, small number of branches, into their strength, being able to offer high interest rate for customers.
Effects on Korean Banking Industry
KDBdirect slowly diminished from the market due to unexpected reason. Since global recession continued after the financial crisis, Korean government realized the importance of having government owned bank to cope with market failure, and decided to cancel the plan to privatize KDB at 2013. Because of the changed policy, KDB decide to reduce their volume of retail banking and started to lower the interest rate gradually. Now, KDB direct no longer offer high interest rate.
Because of the government regulation and insufficient technological support, KDB failed to offer fully functioned direct banking service; it kept relied on bank tellers to open new accounts. However, the basic scheme of giving higher interest rate to customers by using IT technology was widely accepted among other financial institutions in Korea after the success of KDBdiret. For instance, a regional bank, Jeonbook Bank, adopted KDB’s strategy and launched JBdirect at 2013 to overcome their limited coverage with the help of the IT technology. Newly established insurance companies also started offer similar direct insurance products, offering high rate of return to customers who sign contracts through on-line channel. Digital technology allows small financial institutions to compete in different ways.
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(1) Weekly finance and economics trend, Woori financial research institute, Mar. 2014.
(2) The Korea Federation of Banks, 2012
(3) Argument about KDBdirect, The Korea Economic Daily, Mar. 14, 2014