Internet banks' small-business lending boom masks heavy reliance on collateral

Internet-only banks have been rapidly expanding their loans to sole proprietors, but most of that growth has flowed through real estate collateral and government-backed guarantees. Critics say the banks — which once promised to assess creditworthiness through alternative data rather than collateral or credit ratings — are in practice mirroring the approach of traditional lenders when it comes to small-business borrowers.

Second-quarter disclosures from the three internet banks — Kakao Bank, K bank and Toss Bank — show that collateral- and guarantee-backed loans account for 69.1 percent of Kakao Bank's sole-proprietor lending, 45.0 percent of K bank's and 36.9 percent of Toss Bank's.

On the surface, the sector's growth looks impressive. Combined sole-proprietor loans at the three banks surged 51.9 percent over the past year to more than 8.3 trillion won ($6.04 billion). K bank led the charge with a 108.7 percent increase, Kakao Bank followed with 48.0 percent growth, and only Toss Bank contracted, shrinking 4.9 percent.

The nature of that growth, however, raises questions. As of the end of June, collateral- and guarantee-backed loans accounted for around 4.5 trillion won of the three banks' combined 8.34 trillion won in sole-proprietor credit — more than half the total. The concentration is especially pronounced at the two fastest-growing lenders: collateral and guarantee loans at Kakao Bank and K bank rose by about 2 trillion won over the year, representing roughly 70 percent of their combined loan growth of 2.92 trillion won.

Nor is this a temporary phenomenon. The share of collateral- and guarantee-backed lending at both banks has risen for five consecutive quarters without interruption since the second quarter of last year.

The trend shows no sign of reversing. During the third quarter, K bank plans to expand the eligible collateral for its small-office home-office loans from apartments to include housing, officetels and commercial properties, and to broaden the permitted use of funds from working capital to facility investment. The bank has set a target of lifting its coverage of the SOHO secured-loan market from 7 percent to 61 percent. Kakao Bank, which launched a real estate-backed loan product for sole proprietors in the fourth quarter of last year, plans to introduce a refinancing product in the fourth quarter of this year that allows borrowers to switch their secured loans from other banks.

The shift toward collateral has produced tangible results on asset quality. K bank's delinquency rate on sole-proprietor loans fell from 0.93 percent to 0.51 percent — a stark contrast to the five regional banks, whose average delinquency rate rose from 0.86 percent to 1.08 percent over the same period. Overall delinquency rates across the three internet banks also remain stable or improving: Kakao Bank at 0.51 percent, K bank at 0.60 percent and Toss Bank at 1.05 percent.

Experts, however, argue that internet banks — whose mandate is to channel credit to borrowers overlooked by traditional finance through alternative credit assessment — are instead following the conventional playbook. They say the focus should shift away from how much collateral a borrower holds toward how consistently they run their business and what their actual repayment capacity is.

Jeong Min-gye, a professor at Dongguk University's Graduate School of Law, said at a forum on the role of a fourth internet bank held Tuesday that "small merchants, small enterprises and early-stage startups still face significant barriers to financial access." He added that "because traditional finance places heavy weight on collateral, credit ratings and past financial performance, businesses with strong growth potential can still find themselves unable to secure adequate funding."

The internet banks are also taking steps to strengthen alternative credit scoring for sole proprietors. K bank is set to launch a co-branded loan product with Naver Pay this month. Under the arrangement, Naver Financial evaluates a borrower's creditworthiness using Naver Smart Store sales data and payment and content activity history, and K bank incorporates that assessment into its loan approval and limit-setting process.

Kakao Bank applies a "small-business sector-specific credit scoring model" — built using pseudonymized business data — to its unsecured sole-proprietor loans. The bank recently refined the model to cover four distinct business categories: everyday service businesses, retail, restaurants and online sellers.

An official at one of the internet banks said collateral-backed products attract strong customer demand because they allow the bank to extend larger loan amounts, which partly explains the tilt toward secured lending. The official also noted that guarantee loans issued in partnership with regional credit guarantee foundations allow borrowers to benefit from local government support programs, giving the products a role in supplying credit to small merchants in those areas.

An official at another internet bank said that "when the loan book is growing, maintaining a certain level of collateral and guarantee coverage is unavoidable if we are to manage asset quality at the same time."