Legislation of the Act on Special Cases Concerning the Establishment and the Management of Internet-only Banks and Related Legal Issues
The paper reviews the recent legislation of the Act on Special Cases Concerning the Establishment and the Management of Internet-only Banks and relevant legal issues. Internet-only bank is a bank that conducts its banking mainly through electronic financial transaction. The purpose of the legislation was to enable people with lower credit to have access to loans with lower interest rates, and bring positive changes to the banking industry. After the launch of K-Bank and Kakao Bank, the first two Korean internet-only banks, there has been an ongoing discussion regarding the persistence of the separation of banking and commerce principle. While this discussion has been substantially settled, new issue concerning fairness came into play. Another legal issue related to the Act is based on the restriction of scope of business of internet-only banks. As it has been less than a year since the new Act was enforced, keeping a close eye on the actual consequences regarding these issues is required.
With the development of Information and Communication Technology (ICT), the financial industry has been trying to innovate itself with the new technologies. Following the trend, the Financial Services Commission (FSC) announced in 2015 a plan to launch Korean-type internet-only banks. Although its introduction was first promoted in 2008 through the amendment of the related laws, it was foundered due to the unchanged principles of the Banking Act. Learning from this failure, FSC created a task force to conduct a research on ways to prevent the repetition of such barriers. For the first time in twenty-three years, granting preliminary approval for banking license was deliberated, and two consortiums received preliminary approval as a result.
Considering their size, these two banks have grown dramatically in a relatively short period of time. The number of users exceeded 7 million in just one year, and the amount of loans amounts to 8 trillion won. However, being regulated by the Banking Act, they were greatly restricted by ‘the separation of banking and commerce principle’. Whether this principle should also be applied to internet-only banks was a key controversy, along with a few other legal issues.
The situation has changed with the legislation of the Act on Special Cases Concerning the Establishment and the Management of Internet-only Bank (hereinafter referred to as the Internet-only Banking Act or the Act). It was legislated in 26 October 2018 and enforced in 17 January 2019, and its presidential decree was legislated in 15 January 2019.
This paper will cover the key features of the legislation and relevant legal issues. Specifically, the changes in the separation of banking and commerce principle issue and another issue concerning the scope of business provided in the Act are to be covered.
II. Legislation of the Act on Special Cases Concerning the Establishment and the Management of Internet-only Banks
Due to the expansion of low-income bracket and the lack of mid-interest rate loan for those with low credit scores, the polarization of interest rate has become severe under the prolonged economic depression. The need for invigoration of financial supply targeting people with low credit as well as for financial service of quality is evident. The legislation aims to fill these requisitions, to vitalize the participation of innovative businesses within the banking industry, and to establish the institutional foundation for infusing finance with ICT, thus creating new growth engine industry.
2. Definition of Internet-Only Bank
The Internet-only Banking Act defines the “internet-only bank” as “a bank that conducts its banking mainly through the electronic financial transaction(Article 2)”. Here the “electronic financial transaction” refers to the intact, automated transaction taking place through electronic devices according to the Electronic Financial Transaction Act. The word “mainly” implies that most of the business has to take place online, while offline branches are approved only exceptionally. Therefore, the term can be interpreted as a bank that generally owns none or only a few offline branches and conducts most of its business online, either by computer or mobile, and even when it does own a branch, it should be mainly based on automated machines such as ATMs (Automated Teller Machine).
3. Key Contents
The Internet-only Banking Act consists of 23 general provisions and 6 supplementary provisions. This Act has some notable differences compared to the Banking Act. While the latter requires banks to have a capital of at least a hundred billion won, the former requires only twenty-five billion won (Article 4.1.). No non-financial business operators are allowed to hold more than four percent of the total number of outstanding voting stocks of a bank under the Banking Act (Article 16-2), while the restriction is much more relaxed for internet-only banks, with the limit of thirty-four percent (Article 5.1.). In addition, the Internet-only Banking Act puts a much stricter regulation on the credit line of identical borrowers, individuals, and corporate bodies. The Act also bans the act of granting credit to large stockholders (Article 8) and the acquisition of equity securities issued by large stockholders of the bank (Article 9.1) as well as limiting certain acts of large stockholders (Article 10). The Act approves face-to-face transactions only in inevitable cases where the protection and convenience of internet-only bank users are needed.
4. Subject of Application
FSC conducted a pilot project in which it selected a few business operators and granted them a banking license. This was to utilize them as test-beds to verify the chances of success of internet-only banks under the current laws and systems. The selected operators were K-bank and Kakao Bank. After conducting the trial and further research, FSC is planning on giving out permissions to more consortiums.
K-Bank is Korea’s first internet-only bank. Authorized in December 2016, K-Bank launched its business in April 2017 with the initial capital of 250 billion won. Its main shareholders are Woori Bank (10.0%), NH Investment & Securities (10.0%), GS Retail (10.0%), Danal (10.0%), Hanwha Life Insurance (10.0%), and KT (8.0%). As for the term deposits, K-Bank provides higher interest rates compared to commercial banks. Utilizing the infrastructure of one of its main shareholders, GS Retail, K-Bank users are able to withdraw or deposit money from the ATMs installed in GS25 (the convenience store of GS Retail) without any fees. Also, taking advantage of KT’s big-data analysis technology, it provides various banking services whenever and wherever.
2. Kakao Bank
Following close behind K-Bank, Kakao Bank received authorization in January 2017 and launched its business in July 2017 with the initial capital of 300 billion won. Its main shareholders are Koreaholdings (58.0%), Kakao (10.0%), and KB Bank (10.0%). By utilizing the KakaoTalk platform, a mobile messenger platform securing more than 40 million users, it provides payment, loan, and deposit services. The business is concentrated on selling savings, installment savings products and loan products.
III. Related Legal Issues
- Separation of Banking and Commerce Principle
Separation of banking and commerce principle can be defined as “restricting nonbanking activities of banks and banking activities of nonbanking firms”. This idea has prevented the mix of banks in the financial sector and nonbanking businesses in the commercial or production sector of the economy.
As previously mentioned, no non-financial business operator can hold more than four percent of the total number of outstanding voting stocks of a bank under the Banking Act (Article 16-2). The separation of banking and commerce principle has been an essential issue in the banking industry. The principle was established out of concern that banks may be degraded into personal safe of large shareholders, and therefore act in accordance with their interests. In the case of internet-only banks, however, if the stocks mainly belong to the financial sector while the practical management is handled by ICT companies, the restriction of business expansion can be far greater. For this reason, whether to relieve or maintain the intensity of this principle has long been a key issue of internet-only banking. Under the Internet-only Banking Act, non-financial business operators can hold up to 34% of outstanding voting stocks (Article 5.1.). Though the original controversy is mostly settled thanks to the legislation, now the problem lies in whether it is fair to apply a much looser standard to internet-only banks while maintaining that of commercial banks, and a further debate and study are expected to be done in the future.
3. Cases of Other Countries
As for internet-only banks, other countries tend to run more relaxed system regarding separation of banking and commerce principle. In the United States, commercial banks can hold only up to twenty-five percent of industrial capital, which is practically prohibiting the mix of banking and commerce. On the contrary, enterprises can penetrate into internet-only banks through the ILC (Industrial Loan Company) system. Businesses in Japan are required to receive prior approval if their shares are about to go over twenty percent, and the supervision and observation of large shareholders are reinforced if they go over fifty percent.
2. Scope of Business
1. Restrictions on Loaning
Even before the legislation of the Act, opposing arguments were debating on the necessity of limiting the business scope of internet-only banks. As a result of the legislation, internet-only banks have a business scope similar to that of commercial banks. However, a difference exists in that internet-only banks cannot loan to corporate bodies other than small or medium-sized enterprises (Article 6). This can be seen as an effort to prevent internet-only banks from granting credit to its large shareholders since the new law opened up a way for nonfinancial companies to possess and wield greater rights over the bank. However, this regulation can discourage the competitiveness of the banks. Under the Act, internet-only banks are only allowed for microfinance, thus rendering their profitability uncertain. Therefore, the question of whether it is just to limit the business scope of internet-only banks still remains unanswered.
Another problem resulting from this restricting article is that the construction of the law may be ambiguous. The term “corporate body” in Korean includes many different types of corporate bodies, including corporations, juristic foundations, school juristic persons, and many other non-profit juristic persons. Not only is it unclear which of those corporate bodies are included, but also unreasonable outcomes are possible as businesses operating in the form of association will be excluded , therefore being able to use the loan service.
2. Cases of Other Countries
Cases of other countries differ from that of Korea in that they usually do not have a separate law regulating internet-only banks. Countries such as the U.S., Japan, and the EU apply the same regulations to both commercial banks and internet-only banks. Instead of writing down different business scopes directly in law, business models or specific services of each internet-only bank is determined in the process of granting permission. Factors such as parent company’s professionality, capital, and marketability are considered in the process. Thus, internet-only banks of other countries rarely handle all banking services, and tend to be even more limited in their scope of business.
For example, Sallie Mae Bank is an American internet-only bank that only provides education-related loans such as student loans. Regardless of its limited scope, it has become the biggest educational expenses loaning company and continued its growth even when economic recession and external environment changes occurred.
The legislation of the Act on Special Cases Concerning the Establishment and the Management of Internet-only Banks has greatly reduced the burden internet-only banks were facing by loosening the separation of banking and commerce principle. At the same time, it added another issue to the discussion on internet-only banks by limiting the business scope. Whether or not this limitation is fair to internet-only banks still needs more discussion and analysis of the actual results as the Act was enforced just this year. Meanwhile, the wording of the article certainly has room for improvement as its interpretations can be ambiguous.
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