This blog post examines whether relaxing the separation of banking and industry regulations to foster internet-only banks in Korea is truly justified, weighing the pros and cons.

South Korea’s Internet Banks: Innovation or Illusion?

The first internet-only bank in South Korea was K Bank, established under the leadership of telecommunications company KT. When K Bank opened its doors and began operations in April 2017, consumer response was enthusiastic. Within just 100 days of starting banking operations, the number of subscribers exceeded 400,000, and deposits quickly surpassed 610 billion won. Kakao Bank, which began operations in July of the same year, enjoyed even greater popularity. Led by Kakao, this bank rapidly increased its subscriber base by leveraging the familiarity of popular characters from its mobile messenger emoticons and its universal accessibility directly within KakaoTalk. Within 100 days of launch, subscribers surpassed 4 million, and deposits exceeded 4.2 trillion won. During these 100 days alone, Kakao Bank lent 3.39 trillion won to borrowers.
The performance of K Bank and Kakao Bank clearly demonstrates Koreans’ thirst for innovative financial services. K Bank was the first new bank to emerge in the primary financial sector in 24 years, since the establishment of Pyeonghwa Bank. Conventional commercial banks had operated in a closed environment without new competitors for 24 years since 1992, essentially playing in their own league.
Opinions remain divided on the impact these internet-only banks, launched over two years ago, have had on the financial sector. One view is that their emergence created a sense of crisis among existing banks, prompting improvements in mobile banking services and increases in deposit interest rates. This is the so-called ‘catfish effect’. Conversely, others argue that internet-only banks are less innovative than anticipated. Expectations were high that, being led by ICT companies, they would leverage IT technology to offer innovative financial products distinct from traditional banks. However, the actual results have been disappointing. Many criticize them for focusing solely on high-credit, low-interest lending—a straightforward business model lending money at low rates to highly creditworthy individuals. Criticism that internet-only banks are merely a ‘storm in a teacup’ is also significant.

Internet-Only Banks and the Separation of Banking and Industry

Regardless, the trajectory of internet-only banks is noteworthy. This chapter examines the separation of banking and industry regulations through the lens of internet-only banks. The issue of separating banking and industry began gaining traction in August 2018. At the time, the National Assembly fiercely debated plans to relax the separation of banking and industry regulations for K Bank, Kakao Bank, and other upcoming internet-only banks. The core of the deregulation push was to raise the stock ownership cap, allowing IT companies leading the establishment of internet-only banks and participating in management as shareholders to hold larger stakes than currently permitted. This relaxation was necessary because only then could KT and Kakao, the companies that spearheaded the establishment of K Bank and Kakao Bank, become the largest shareholders and effectively lead the management of those banks.
First, let’s understand what the separation of banking and industrial capital regulations are, and when and why this system was introduced. These regulations prevent industrial capital, meaning non-financial companies, from participating in bank management. The term ‘financial-industrial separation’ is also used, meaning the separation of finance and industrial capital, but both terms convey the same meaning.
The industrial capital restriction is applied by limiting the bank shares that non-financial companies can hold. Therefore, for large commercial banks like Kookmin Bank and Shinhan Bank, non-financial companies can only hold up to a 10% stake. Even if a shareholder holds the maximum 10% stake, the portion of shares that grants the right to participate in bank management through shareholder meetings, i.e., voting rights, is capped at a maximum of 4%. This restriction on holding voting shares to a maximum of 4% is also known as the ‘4% rule’.
The separation of banking and industry regulations were introduced in Korea in 1982. They were added during a revision of the Banking Act at that time, driven by concerns that large corporations, rapidly expanding in size amid high economic growth, might extend their reach into the financial sector, potentially leading to excessive concentration of economic power in one area. There was also worry that companies needing capital to enter new businesses might establish banks and then use depositors’ savings as if they were their own funds. As a result, the bank-industry separation regulation was introduced, strictly limiting the participation of general corporations in bank management.
The intensity of the bank-industry separation regulation applied varies depending on the size of the bank. Based on voting rights shares, general corporations can hold up to 4% of shares in commercial banks and up to 15% in regional banks. For smaller savings banks, general corporations can hold up to 100% of the shares. For a time, the separation of banking and industry regulations were maintained without significant controversy. However, the situation changed as advanced countries overseas, spurred by developments in information and communication technology, began permitting the launch of banks operating differently from traditional banks—namely, internet-only banks. Domestically, voices began emerging arguing that to develop the financial industry, internet-only banks must be introduced, and to achieve this, the separation of banking and industry regulations, which prevent general companies including IT firms from entering the financial sector, must be relaxed.
As mentioned earlier, internet-only banks first appeared in Korea in 2017. K Bank, with KT’s participation, opened its doors in April that year, and Kakao Bank, with Kakao’s participation, began operations in July. In fact, proposals to introduce internet-only banks led by non-financial companies were previously pursued in 2001 and 2008 but were thwarted by the separation of banking and industry regulations.
According to data from the Korea Institute of Finance, the first internet-only bank in the US was established in 1995. Other advanced economies also generally permitted the launch of internet-only banks starting in the early 2000s. China opened its first internet-only bank two years before Korea. Notable overseas internet-only banks include Ally Bank, funded by the American automaker General Motors (GM); Rakuten Bank, established by the Japanese e-commerce company Rakuten; and Tesco Bank, owned by the British retailer Tesco.
So, what distinguishes internet-only banks from traditional banks? What special advantages do they offer that lead to persistent calls for deregulation to advance the financial industry?
The primary advantages of internet-only banks are the convenience they offer users in accessing financial services and their relatively lower loan interest rates compared to commercial banks. Internet-only banks do not operate separate offline branches. This means all banking transactions can be handled without visiting a physical location. This is referred to in technical terms as ‘non-face-to-face operations’. Using an internet-only bank eliminates the need to visit an offline branch even when opening an account. Even without separate authentication methods like a digital certificate or an OTP (one-time password) device, an account can be opened simply by installing the bank’s application on a smartphone. Once the account is created, you can immediately apply for a loan or subscribe to a deposit. In short, it has dramatically lowered the barrier to accessing financial services. Fees for various financial services, including overseas remittances, are either nonexistent or lower than those at conventional banks. It’s convenient because you can send money using just a KakaoTalk message or text message, without needing to enter the recipient’s account number.
By not operating offline branches, Kakao Bank can reduce rental and labor costs. This allows it to offer depositors higher interest rates and borrowers lower loan rates. However, the government’s approval of internet-only banks wasn’t solely driven by user convenience and loan rates. Improving mobile banking and reducing fees are things traditional banks could also achieve if they had the will.
The persistent argument for creating an environment where internet-only banks can truly thrive stems from the development of the Fintech industry. Fintech is a portmanteau of the English words ‘Finance’ and ‘Technology’. It also refers to companies providing services that combine finance and IT technology. It was precisely to foster the revival of this fintech industry that the launch of internet-only banks was permitted.

Without deregulation, there can be no industry development!

K Bank and Kakao Bank, created under the leadership of IT companies, were anticipated from their preparatory stages to offer differentiated fintech products distinct from traditional banks. Indeed, this rationale led to the first new banking license granted in 24 years. Examples of fintech products internet-only banks can offer include mid-interest rate loan services. These utilize big data to meticulously assess a loan applicant’s creditworthiness and provide loans at lower interest rates than traditional banks. As anyone who has borrowed from a bank knows, individuals with low credit scores find it difficult to secure unsecured loans based solely on credit from commercial banks. Until now, those with low credit scores had no choice but to turn to secondary financial institutions, paying high interest rates to borrow money.
By analyzing the various data accumulated by users in their daily lives, credit scores can be calculated more accurately. In fact, Kakao Bank utilizes billions of pieces of accumulated big data, such as online shopping purchase histories and SNS activity, in its loan screening process. K Bank also utilizes smartphone bill payment records and payment histories from various merchant stores in its loan assessments. This represents a relatively groundbreaking approach compared to traditional banks, which have relied solely on a few standardized metrics like employer, income level, and credit score. Sticking rigidly to traditional frameworks means that even the most diligent individuals, who would never default under any circumstances, might not receive a high credit rating.
Of course, it remains impossible—even for internet-only banks—for someone with a lower annual salary to borrow money at a lower interest rate than someone earning more. However, utilizing big data in loan assessments allows for a more thorough verification of creditworthiness through the applicant’s daily life. Individuals with medium to low credit scores, who previously had no choice but to borrow at high interest rates, can now access loans at lower rates if they receive a high credit rating through the internet-only bank’s proprietary credit assessment system. This utilization of big data represents the core of fintech, the convergence of finance and IT technology.
So, several years after the launch of internet-only banks, what level of success have they achieved, and what challenges remain ahead? The numbers show promising results. As of July 2018, Kakao Bank had over 6.33 million subscribers, with deposits totaling approximately 8.63 trillion won. Its loan balance reached 7 trillion won.
When K Bank and Kakao Bank first launched, the government and financial sector anticipated they would create a ‘catfish effect’. The pike effect theory originates from the observation that when a single pike is released into an aquarium full of sardines, the sardines swim diligently to avoid being eaten, staying healthy until they reach their destination. In other words, when a formidable competitor emerges, existing companies improve their products and services to survive the competition. Indeed, with the emergence of internet-only banks, commercial banks improved their services and introduced new financial products to prevent customer loss. They enhanced mobile banking services, lowered various fees, and reduced interest rates on loan products, appearing to demonstrate the catfish effect working as expected.
However, despite these achievements, many financial experts assess the impact of internet-only banks on the financial sector as a ‘storm in a teacup’. They point out that, rather than launching innovative financial products based on IT technology as initially hoped, these banks largely replicated the business practices of existing banks. The growing calls for relaxing the separation of banking and industry regulations in 2018 are also related to this situation. There is a growing opinion that the stagnant financial industry, lacking an engine of innovation, should be revitalized using internet-only banks as a foundation. The logic is to relax regulations to allow IT companies to become the largest shareholders of banks, thereby enabling them to actively pursue their own agendas.
K Bank and Kakao Bank derive their names from the missions of their respective IT parent companies, KT and Kakao. While these companies led the establishment process, in terms of official shareholding, KT and Kakao are merely one among many shareholders. As of 2018, Kakao’s stake in Kakao Bank was still only 10%. Moreover, due to regulations, only 4% of its shares carried voting rights. The remaining shares were held by Korea Financial Holdings (58%), Kookmin Bank (10%), SGI Seoul Guarantee (4%), and several other companies. Compared to Korea Financial Group, Kakao held a very small stake. The same was true for K Bank. KT’s stake here was only 8%. Again, the voting shares amounted to just 4%. The remaining shares were held by 19 companies, including Woori Bank, NH Investment & Securities, Hanwha Life Insurance, and DGB Capital.
Expanding a business requires money, and banks are no exception. More capital means more loans can be extended to applicants and more funds can be invested to develop new services. However, until now, it was practically impossible for domestic internet-only banks to attract large-scale investments. For these banks to expand their business more aggressively, the IT companies leading them would need to make substantial investments. Yet, despite having the funds, Kakao and KT were unable to invest. This was because the separation of banking and industry regulations blocked the path to new investment through paid-in capital increases. No company in the world would foolishly push ahead with investment when doing so wouldn’t increase their stake. Only when IT companies invest large sums to become the largest shareholders can they fully steer the management of internet-only banks and actively develop fintech technologies and new services.
This is precisely why there have been persistent criticisms that internet-only banks, even if they exist, are merely half-baked under the bank-industry separation regulations. Fortunately, in July 2018, President Moon Jae-in stated, “Bank-industry separation regulations should be relaxed, specifically for internet-only banks.” This sparked rapid discussions at the National Assembly level to ease these regulations.
In August 2018, the National Assembly discussed the specifics of the ‘Special Act on Internet-Only Banks,’ which contained provisions to relax the bank-industry separation regulations applied to internet-only banks. There were various issues and opinions regarding the relaxation of these regulations. First, there were fundamental objections to relaxing the regulations themselves, with some arguing that the existing restrictions should not be loosened. This stems from concerns that relaxing the rules could allow banks to become private cash cows for large corporations. There is worry that a large corporation, as a major shareholder of a bank, could withdraw and use bank funds as if they were its own money. Critics also argued that even if the separation rules were relaxed only for internet-only banks, once the rules were loosened, it could set a precedent for relaxing the regulations applied to general commercial banks as well. The fact that advanced economies like the United States still maintain the separation of banking and industry regulation itself supported their argument.
In response, proponents of relaxing the separation regulations countered that enacting laws preventing conglomerates from obtaining loans from banks where they are major shareholders could prevent such adverse effects. They further argued that while advanced countries do limit the ownership cap for industrial capital in banks, conglomerates can hold larger stakes with government approval. While industrial capital’s bank shareholding limits are capped at 25% in the US, 20% in Japan, and 50% in Europe, Japan’s Rakuten Bank and Sony Bank are actually 100% owned by Rakuten and Sony, respectively, under government approval.
Proponents also argue that empowering IT companies—whose very DNA differs from traditional financial institutions—is essential for advancing the entire fintech industry. This includes developing credit analysis systems using big data and AI, and enhancing security through blockchain technology. They contend that allowing these companies to lead the management of internet-only banks is crucial for genuine innovation.
How did the debate surrounding the separation of banking and industry conclude? After twists and turns, a special law relaxing the separation regulations specifically for internet-only banks passed the National Assembly in September 2018. The core provision of the law relaxed restrictions, allowing general corporations to hold up to 34% of an internet-only bank’s shares. However, even for general companies, conglomerates with controlling shareholders were barred from establishing internet-only banks. Only companies with a certain minimum proportion of ICT assets were permitted to enter the internet-only banking sector.
With the bank-industry separation regulations applied to internet-only banks somewhat relaxed, the possibility of a third and fourth internet-only bank launching increased. The financial industry anticipates that several large corporations with sufficient capital and extensive big data accumulated through other businesses will enter the internet-only banking sector. Indeed, e-commerce firm Interpark and online securities firm Kiwoom Securities are preparing to enter this market. Naver also has significant potential. It will be interesting to see how innovation unfolds in the financial sector and fintech industry going forward.