## EXECUTIVE SUMMARY

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---

### Introduction and overarching findings
- Technological innovation in Korea could deepen the financial system, increasing product offerings and lowering transaction costs.
- Korea’s legal framework (including the announced “open banking system” and anticipated amendments to electronic financial transactions and personal data laws) will shape the direction of innovation and competition.
- Korea’s highly modernized and digitally connected financial sector will amplify changes to market structure and competition.
- Technology-driven changes to payments and customer relationships may have far-reaching implications for financial stability, especially when catalyzed by legal adjustments that facilitate innovation and competition.
- Potential benefits of new fintech entrants:
  - improve efficiency and customer choice in payment services (reducing transaction costs, providing greater transparency with simpler financial products, enabling tighter controls over spending and budgeting).
- Potential risks and negative effects:
  - increasing interconnectedness and complexity in the financial sector;
  - greater operational risk;
  - negative impact on the profitability of incumbent banks.

### Key cross-cutting findings on market structure and policy stance
- Entry of large technology companies in the payment services market is beginning to alter market structure, together with adjustments to Korea’s legal framework under the authorities’ multi-prong work plan.
- Authorities should closely monitor changes to market structure and act promptly to ensure orderly and coordinated roll-out of the work plan components accelerating financial innovation.
- Proper development and risk management could enable incumbent banks and new fintech entrants to compete alongside each other in the payment services value chain.
- A close watch is required on heightened operational risks and on negative impacts to incumbent banks’ business models resulting from parallel legal initiatives.

### Table of key recommendations (as presented)
- Recommendation 1
  - Foster certainty and market confidence in the full implementation of the “open banking system,” including the formulation of its legal foundation, by giving heightened attention to the increased security and operational risks such as those that accompany the increased sharing of data and growing connectivity among diverse market players (see ¶42, FSC)
  - Timing*: ST
  - Priority**: H
- Recommendation 2
  - Take a coordinated and gradual approach that prioritizes stability with regard to introducing the “open banking system” and relaxing the legal restrictions for electronic financial transactions and the usage of personal data, with regular assessment of financial sector impact (see ¶45, BOK, FSC, and FSS)
  - Timing*: C
  - Priority**: M
- Legend from source:
  - Timing*: C = Continuous; I = Immediate (within one year); ST = Short Term (within 1–2 years); MT = Medium Term (within 3–5 years)
  - Priority**: H= High; M= Medium; L=Low.

### Evolution of retail payments and primary drivers
- Characteristics of Korea’s retail banking sector:
  - great financial institution depth;
  - a saturated credit card market;
  - high smartphone penetration;
  - customer eagerness to embrace cutting-edge technologies.
- Historical drivers:
  - Transition toward an inclusive, modern retail payments market began decades ago with policy measures introduced after the Asian financial crisis (examples noted: a 20% deduction of annual credit card payments from taxable income and obliging merchants to accept credit cards).
  - Korea was the first country to commercialize the 5G mobile network, enabling faster handling of data in higher capacity and supporting mobile payment services.

### Fintech and emerging payment services — market composition and usage
- 41% of fintech companies in Korea belong to the payment sector.
- The number of registered electronic financial service providers: 144 as of November 2019, compared to 67 in 2014.
- Major non-bank technology payment applications and reach:
  - Samsung Pay (Samsung Electronics).
  - KakaoPay (Kakao) — over 44 million active users in Korea as of June 2019, accounting for more than 90% of Korea’s mobile messenger market.
  - Naver Pay (Naver) — over 50 million monthly active users in 2018.
- Two dominant product forms:
  - Easy payments
    - Definition: smartphone-initiated payments relying on existing third-party infrastructures (e.g., credit card systems) for back-end processing and settlement; front-end verification of pre-stored credit card information and smartphone authentication (password or biometric).
    - Usage (BOK): average of 3.92 million times per day in 2018, an increase of 87.5% from 2017.
    - Average daily volume: KRW126 billion ($89 million USD), up 86.2%.
  - Simple e-money transfers
    - Definition: smartphone-initiated payments where users first load a prepaid value to generate an electronic currency balance with the service provider; processed/settled on a system proprietary to the service provider.
    - Usage (BOK): average daily volume increased 194.1% to KRW104.5 billion ($92.13 million USD) in 2018.
    - Number of daily transfers: 1.41 million in 2018, a 102.5% rise.
- Dependence on banks:
  - Easy payments: providers rely directly on banks for processing and settlement of each payment transaction.
  - Simple e-money transfers: customers must have a bank account or debit card to channel money into and out of provider networks; providers hold pooled bank accounts in their own name for customer funds and rely on banks for access to the interbank settlement system.
- Market dynamics:
  - Popularity of large technology company services marks a shift from a previously bank-centered payment services market.
  - Non-financial technology companies are leading the current wave of innovation in payment services, unlike past innovations driven by financial institutions.

### Consumer rankings (Korea Consumer Board, Consumer satisfaction for mobile payments, 2019)
- Kakao Pay — Sep. 2014
- SK Pay (formerly Syrup Pay) — Apr. 2015
- SSG Pay — Jul. 2015
- Naver Pay — Jun. 2015
- Samsung Pay — Aug. 2015
- Payco — Aug. 2015

### Financial stability considerations
- Technology-driven change, catalyzed by legislative initiatives, may place earnings pressure on Korean banks already affected by low interest rates, aging-related shifts, and almost identical banking business models.
- Incumbent banks may find it increasingly difficult to respond quickly and competitively to large technology companies entering payment services, which could:
  - reduce the resilience of banks by affecting their profitability;
  - reduce the stability of their funding.
- Critical uncertainty: how fintech business models and legislative initiatives may alter the deposit and liability base in the Korean banking system.
- Authorities’ multi-pronged legal initiatives can drive competition with efficiency gains and consumer benefit, while increasing data sharing and IT connectivity—introducing expanded operational and reputational risks.

---

### Box 2. New Drivers of Innovation in Financial Services: Case Study of Samsung Pay

### Samsung Pay — product, adoption, and drivers of popularity
- Launch: August 2015.
- Technologies: NFC and MST enabling an offline payment model compatible with legacy card terminals.
- User experience:
  - Ease of use: swipe smartphone, select pre-linked card, authenticate (e.g., fingerprint), hold near terminal.
  - Ubiquity: compatible with most existing merchant card reader terminals, including magnetic-stripe terminals.
  - Security: Samsung Knox segregates sensitive data; Samsung Pay uses tokenization (one-time-use transaction codes) akin to EMV-chip card transactions.
- Adoption and volumes in Korea:
  - Surpassed a total of 14 million users (announced April 2019).
  - Handled more than KRW40 trillion ($34 billion USD) in accumulated transaction volume in Korea (announced April 2019).
  - Accounted for 80% of the offline easy payment services market in Korea in 2018.

### Techfin emergence and other platforms
- “Techfin” concept: large technology companies delivering financial services as part of broader platforms, enabling users to stay within the platform.
- Kakao/Kakao Pay
  - Launched in 2014.
  - $200 million USD investment from Ant Financial in 2017.
  - 30 million users in August 2019.
  - Easy payment service handled more than KRW22 trillion ($18.45 billion USD) in accumulated transaction volume in Korea as of the first half of 2019.
  - Features: offline QR-code payments, remittance, invoice sending, fraud detection.
- Naver/Naver Pay
  - Launched in 2015.
  - Integrates search, shopping, loyalty points, and simple e-money transfers to retain users within Naver.

### Impact on incumbent banks
- Market concentration: six large banks command 70%-80% of the system’s loans and deposits.
- Digital adoption (fourth quarter of 2018):
  - Web-based banking and mobile application banking accounted for 87% of bank account queries.
  - Web-based banking and mobile application banking accounted for 53% of all bank account transfers.
- Bank responses:
  - Expanded digital teams, dedicated departments, fintech incubation and innovation labs.
  - Example cooperation: April 2019 memorandum between Shinhan Financial Group and Korea Growth Investment Corp to foster fintech investments.
- Profitability pressures:
  - Korean banks underperform peers; earnings outlook pressured by rising technology-driven competition, low interest rate environment, limited domestic expansion opportunities, and aging population.
  - Rising costs to maintain market position and modest cost savings strain profit margins.
  - Offshore expansion destinations for subsidiaries include Vietnam, Thailand, and Myanmar.
- Regulatory change effects:
  - Introduction of an “open banking system” will give fintech companies and banks new access to the interbank settlement system, intending to promote competition and enable transfers between customer accounts at any bank.

---

### The Korean “open banking system” — design, operations, and implications

### Overview and design objectives
- Designed as an infrastructure open to all licensed fintech companies and banks to access other banks’ systems in Korea.
- Intended to facilitate two types of Interface Providers:
  - Providers enabling customers to initiate payments from their bank accounts to a beneficiary, bypassing card payment systems.
  - Providers offering information aggregation services that consolidate transaction histories and balances from multiple financial institutions.
- Authorities designed the system with goals similar to PSD2: foster competition and innovation by granting licensed Interface Providers access—subject to customer consent—to account and transaction information held by Back-end Banks.
- Critical operational difference from PSD2: licensed Interface Providers connect to an interbank settlement system operated by the KFTC, which routes inquiries and processes transactions through the KFTC-operated payment system connecting to Back-end Banks, rather than direct bank-to-provider API connections.

### Characteristics, settlement, and insurance
- Interface Providers can be licensed fintech companies or incumbent banks; commercial banks may compete with fintech entrants in providing interface services.
- From a customer perspective, Interface Providers offer:
  - Better, faster, more user-friendly interfaces;
  - Capability to initiate payments from customer accounts at Back-end Banks;
  - Dashboard platforms for spending analysis, financial advice, and personalized offers.
- Settlement and finality:
  - Transactions through the open banking system are settled among Back-end Banks the next business day via payment netting by the BoK.
  - Settlement finality among Back-end Banks is guaranteed by a relevant law.
- Insurance requirement:
  - Interface Providers using the “open banking system” will be required to take out an insurance policy which covers a certain percentage of their daily withdrawal limits (on average 200%, with the prescribed percentage varying across Interface Providers based on risk profile).

### Simple e-money transfers and data visibility
- The system is expected to facilitate simple e-money transfer services by fintech companies:
  - Interface Providers can allow customers to generate electronic currency balances via transfer from their bank account and to redeem balances via transfer to their bank account more efficiently and at lower cost.
  - Simple e-money transfers move entirely between digital wallets of the Interface Provider and do not make direct contact with Back-end Banks, preventing those banks from tracking or analyzing individual transactions of their customers.
- Interface Providers are beginning to accumulate customer spending and financial position data traditionally held by banks, reducing Back-end Banks’ visibility and potentially hindering credit risk monitoring and personalized product offers.

### Earlier “open API system” and pilot roll-out
- August 2016 “open API system” limited access to a pool of 16 commercial Back-end Banks via standardized APIs; access was limited to small fintech firms and fees charged by Back-end Banks were approximately KRW400-500 per transaction.
- Pilot roll-out status (as of October 2019):
  - All 18 commercial banks in Korea are participating in a pilot roll-out and opening access to customer accounts and transaction information.
  - In October 2019, 10 banks participated voluntarily as Interface Providers, with plans to expand participation in mid-December 2019 to the remaining eight commercial banks and all non-bank fintech firms approved by the KFTC.
  - The 18 banks are: BNK Kyongnam Bank, Busan Bank, Citibank Korea, Daegu Bank, Jeju Bank, Jeonbuk Bank, K Bank, Kakao Bank, KDB, KEB Hana Bank, IBK, KB Kookmin Bank, Kwangju Bank, NH Bank, SC Bank Korea, SH Bank, Shinhan Bank, Woori Bank.
  - The 10 banks are: NH Bank, Shinhan Bank, Woori Bank, KEB Hana Bank, IBK, KB Kookmin Bank, Busan Bank, Jeju Bank, Jeonbuk Bank and BNK Kyongnam Bank.

### Operational resilience, third-party risk, and data security concerns
- Prescriptive requirements replacing bilateral contractual relationships reduce Back-end Banks’ discretion in oversight and monitoring of Interface Providers.
- Full participation of all 18 commercial banks means a vulnerability in one Interface Provider could impact the broader financial system.
- Centralized data sharing via the KFTC increases the “surface area” for cyber-attacks as more data is shared with more parties.
- Incompatibilities among Back-end Banks and between legacy systems and state-of-the-art Interface Providers raise operational risk.
- Preventative security controls and threat detection by the KFTC could be complemented by a legal framework addressing resiliency and continuity with coordination among end-to-end participants, including:
  - Clear requirements and procedures for outage or breach notification, reporting, and information sharing.
  - Legal certainty on loss allocation calibrated to incentivize parties to minimize system risk exposure.

### Medium- to long-term competitive dynamics and systemic risks
- Large technology firms can leverage existing customer bases, brand recognition, and technology to achieve scale rapidly; BIS characterization: (D)ata analytics, (N)etwork externalities, and interwoven (A)ctivities producing a “DNA” feedback loop.
- Commercial banks have not been as effective as big techs in harnessing the “DNA” feedback loop.
- Concentration risk may increase among Interface Providers if large technology firms gain significant market share.
- Implications for banks and market structure:
  - Loss of banks’ direct customer interaction to Interface Providers can result in loss of customer data and cross-selling opportunities, potentially commoditizing Back-end Banks.
  - Sharing of customer data with Interface Providers may further unbundle formerly integrated services.
  - Customers’ improved ability to compare fees may erode Back-end Banks’ income and funding; platforms like Bank Salad facilitate comparison, encouraging more frequent movement of retail deposits and aggressive pricing.
  - Higher depositor churn may pressure banks to raise rates to acquire and retain deposits, putting pressure on profitability and increasing liquidity risk.
- These risks are forward-looking given payment services provision by large technology companies is relatively nascent in Korea.

### Policy interaction and implementation guidance
- Initiatives to encourage intense competition in payment services, introduced in parallel with relaxing legal restrictions for electronic financial transactions and personal data usage, should be implemented in a coordinated and gradual manner prioritizing stability.
- Rapid growth at the expense of profitability and sustainability could introduce structural flaws and crowd out new business models.
- Authorities would benefit from close engagement with the Korean competition authority and regular assessment of stability risks, monitoring the effect of large technology firms’ activities on incumbent institutions’ ability to generate capital via retained profits.
- Authorities should stay vigilant of market developments and systemic risk implications given the potential for large technology firms to rapidly achieve scale.

### Recommendations (reiterated)
- Foster certainty and market confidence in full implementation of the “open banking system,” including formulation of its legal foundation, by giving heightened attention to increased security and operational risks accompanying increased data sharing and connectivity (see ¶42).
- Take a coordinated and gradual approach that prioritizes stability in introducing the “open banking system” and relaxing legal restrictions for electronic financial transactions and personal data usage, with regular assessment of financial sector impact (see ¶45).

*Source: Republic of Korea — IMF Financial Sector Assessment Program, Executive Summary and related chapter excerpts (as of December 18, 2019).*

### EXECUTIVE SUMMARY __________________________________________________________________________ 4

### EXECUTIVE SUMMARY

### Introduction
- Technological innovation in Korea holds great potential for the deepening of its financial system, that could lead to an increase of product offerings and lowering of transaction costs.
- Korea’s financial sector legal framework, particularly the recently announced open banking initiative and anticipated amendments to the legal frameworks for electronic financial transactions and use of personal data, will play a key role in shaping the direction of innovation and competition in the financial sector.
- Korea’s already highly modernized and digitally connected financial sector will amplify the impact of these changes to market structure and competition.
- Technology-driven changes to payments and customer relationships may have far-reaching implications for financial stability, especially when catalyzed by Korea’s approach to adjusting the legal framework designed to facilitate innovation and competition.
- New fintech entrants might improve efficiency and customer choice in payment services (reducing transaction costs, providing greater transparency with simpler financial products, enabling tighter controls over spending and budgeting) while potentially introducing:
  - increasing interconnectedness and complexity in the financial sector;
  - greater operational risk; and
  - negative impact on the profitability of incumbent banks.

### Key cross-cutting findings on market structure and policy stance
- The successful entry of large technology companies in the payment services market is beginning to alter market structure, together with adjustments to Korea’s legal framework under the authorities’ multi-prong work plan to facilitate innovation, affecting the degree of concentration and competition.
- The authorities should closely monitor changes to market structure and act promptly to ensure orderly and coordinated roll-out of their work plan’s components of accelerating financial innovation.
- Korea’s commitment to innovation, modernization, and competition is in the right direction. Proper development and risk management could enable incumbent banks and new fintech entrants to compete alongside each other in the payment services value chain.
- A close watch is required on heightened operational risks and changes to market structure that result from the parallel initiatives to adjust the legal framework, as well as their negative impact on the viability of incumbent banks’ business models.

### Table of Key Recommendations (as presented)
- Recommendation 1
  - Foster certainty and market confidence in the full implementation of the “open banking system,” including the formulation of its legal foundation, by giving heightened attention to the increased security and operational risks such as those that accompany the increased sharing of data and growing connectivity among diverse market players (see ¶42, FSC)
  - Timing*: ST
  - Priority**: H
- Recommendation 2
  - Take a coordinated and gradual approach that prioritizes stability with regard to introducing the “open banking system” and relaxing the legal restrictions for electronic financial transactions and the usage of personal data, with regular assessment of financial sector impact (see ¶45, BOK, FSC, and FSS)
  - Timing*: C
  - Priority**: M

- Legend from source (preserve as presented in Table 1):
  - Timing*: C = Continuous; I = Immediate (within one year); ST = Short Term (within 1–2 years); MT = Medium Term (within 3–5 years)
  - Priority**: H= High; M= Medium; L=Low.

### Evolution of retail payments and primary drivers
- Korea’s retail banking sector is characterized by:
  - great financial institution depth;
  - a saturated credit card market;
  - high smartphone penetration; and
  - customer eagerness to embrace cutting-edge technologies.
- Korea’s transition toward an inclusive, modern retail payments market began decades ago, including policy measures introduced after the Asian financial crisis (example measures noted: a 20% deduction of annual credit card payments from taxable income and obliging merchants to accept credit cards).
- Korea was the first country to commercialize the 5G mobile network, enabling faster handling of data in higher capacity and supporting mobile payment services.

### Fintech and emerging payment services
- Market composition and fintech participation:
  - 41% of fintech companies in Korea belong to the payment sector.
  - The number of registered electronic financial service providers stood at 144 as of November 2019, compared to 67 in 2014.
- Major non-bank technology company payment applications and user reach:
  - Samsung Pay, offered by Samsung Electronics.
  - KakaoPay, offered by Kakao (with over 44 million active users in Korea as of June 2019, accounting for more than 90% of Korea’s mobile messenger market).
  - Naver Pay, offered by Naver (with over 50 million monthly active users in 2018).
- Two dominant product forms described:
  - Easy payments
    - Definition: payments initiated by smartphones to purchase goods or services, online and offline, relying on existing third-party infrastructures (e.g., credit card systems) for back-end processing and settlement; front-end verification of pre-stored credit card information and convenient smartphone authentication (password or biometric).
    - Usage statistics (BOK): average of 3.92 million times per day in 2018, an increase of 87.5% from 2017.
    - Average daily volume: KRW126 billion ($89 million USD), up 86.2%.
  - Simple e-money transfers
    - Definition: payments initiated with smartphones where the user first loads a prepaid value to generate an electronic currency balance with the service provider; payments/transfers use the electronic currency balance and are processed/settled on a system proprietary to the service provider in balances of electronic currency.
    - Usage statistics (BOK): average daily volume increased 194.1% to KRW104.5 billion ($92.13 million USD) in 2018.
    - Number of daily transfers: 1.41 million in 2018, a 102.5% rise.
- Dependence on banks
  - For easy payments: service providers rely directly on banks for processing and settlement of each payment transaction.
  - For simple e-money transfers: customers must have a bank account or debit card to channel money into and out of the provider’s network; providers hold pooled bank accounts in their own name for customer funds and rely on banks for access to the interbank settlement system.
- Market dynamics
  - The popularity of services offered by large technology companies marks a shift from a previously bank-centered payment services market.
  - Non-financial technology companies are leading the current wave of financial innovation in payment services, unlike past innovations driven by financial institutions.

### Top-rated easy payment services (consumer survey)
- Kakao (online social media company, Korea’s leading instant messaging application): Kakao Pay — Sep. 2014
- SK Planet (internet platform company, including e-commerce): SK Pay (formerly Syrup Pay) — Apr. 2015
- Shinsegae (department store franchise): SSG Pay — Jul. 2015
- Naver (internet content service company, Korea’s leading web portal and search engine): Naver Pay — Jun. 2015
- Samsung Electronics (electronics company): Samsung Pay — Aug. 2015
- NHN Entertainment (information technology company): Payco — Aug. 2015
- Source of survey: Korea Consumer Board, Consumer satisfaction for mobile payments, 2019.

### Financial stability considerations highlighted
- Technology-driven change, catalyzed by legislative initiatives, may place earnings pressure on Korean banks already affected by low interest rates, aging-related shifts, and almost identical banking business models.
- Incumbent banks may find it increasingly difficult to respond quickly and competitively to the successful entry of large technology companies into payment services and heightened market competition, which could:
  - reduce the resilience of banks by affecting their profitability; and
  - reduce the stability of their funding.
- Critical uncertainty: how fintech business models and legislative initiatives may alter the deposit and liability base in the Korean banking system.
- The authorities’ multi-pronged legal initiatives have the potential to drive competition with efficiency gains and consumer benefit, while increasing data sharing and IT connectivity among diverse market players—introducing an expanded set of operational and reputational risks.

*Source: Republic of Korea — IMF Financial Sector Assessment Program, Executive Summary (as of December 18, 2019).*

### Box 2. New Drivers of Innovation in Financial Services: Case Study of Samsung Pay

### Box 2. New Drivers of Innovation in Financial Services: Case Study of Samsung Pay

### Samsung Pay: product, adoption, and drivers of popularity
- Launch: August 2015.
- Technologies: NFC and MST enabling an offline payment model compatible with legacy card terminals.
- User experience:
  - Ease of use: swipe smartphone, select pre-linked card, authenticate (e.g., fingerprint), hold near terminal.
  - Ubiquity: compatible with most existing merchant card reader terminals, including older magnetic-stripe terminals, removing need for merchants to update systems or install new readers.
  - Security: Samsung Knox segregates sensitive data and implements additional authentication controls; Samsung Pay uses tokenization (one-time-use transaction codes) akin to EMV-chip card transactions.
- Adoption and volumes in Korea:
  - Surpassed a total of 14 million users (announced April 2019).
  - Handled more than KRW40 trillion ($34 billion USD) in accumulated transaction volume in Korea (announced April 2019).
  - Accounted for 80% of the offline easy payment services market in Korea in 2018.

### Techfin emergence and other technology platforms
- Concept: “Techfin” (term coined 2016) — large technology companies delivering financial services as part of broader platforms, enabling users to stay within the platform.
- Examples:
  - Kakao/Kakao Pay:
    - Kakao Pay launched in 2014.
    - $200 million USD investment from Ant Financial in 2017.
    - 30 million users in August 2019.
    - Easy payment service handled more than KRW22 trillion ($18.45 billion USD) in accumulated transaction volume in Korea as of the first half of 2019.
    - Features: offline QR-code payments (payment details via Kakao Talk), remittance, invoice sending, fraud detection.
  - Naver/Naver Pay:
    - Naver Pay launched in 2015.
    - Integrates search, shopping platform, easy payment services, loyalty points, and simple e-money transfers to keep users within Naver application.

### Impact on incumbent banks
- Market concentration: six large banks command 70%-80% of the system’s loans and deposits.
- Digital adoption (fourth quarter of 2018):
  - Web-based banking and mobile application banking accounted for 87% of bank account queries.
  - Web-based banking and mobile application banking accounted for 53% of all bank account transfers.
- Bank responses:
  - Expanded digital teams, dedicated departments, fintech incubation and innovation labs.
  - Examples of cooperation and investment: April 2019 memorandum between Shinhan Financial Group and Korea Growth Investment Corp to foster fintech investments.
- Profitability pressures and risks:
  - Korean banks underperform peers; earnings outlook pressured by rising technology-driven competition, low interest rate environment, limited domestic expansion opportunities, and aging population.
  - Banks facing rising costs to maintain market position and modest cost savings — strain on profit margins.
  - Offshore expansion: Vietnam, Thailand, and Myanmar noted as important markets for Korean bank subsidiaries.
- Regulatory change effects:
  - Introduction of an “open banking system” will give fintech companies and banks new access to the interbank settlement system, intending to promote competition and enable transfers between customer accounts at any bank.

### Institutional setting and legal framework for retail payment services
- Authorities and roles:
  - FSC develops and executes financial sector policy; FSS is enforcement arm.
  - BOK responsible for management and oversight of payment and settlement systems under the Bank of Korea Act.
- Legal instruments:
  - EFTA enacted 2006 (last amended May 2013) to ensure security and reliability of electronic financial transactions and to establish supervision of service providers.
  - Additional laws: Framework Act on Electronic Documents and Transactions, Digital Signature Act, Issuance and Distribution of Electronic Bills Act, and the Foreign Exchange Transactions Act.
- Rules-based (white-list) approach:
  - Only activities explicitly recognized and licensable under law are allowed.
  - Viewed as methodical and formalistic and can pose challenges for fintechs introducing new business models.
- Personal data protection:
  - Based on the Personal Information Protection Act and sector-specific laws.
  - CIUPA governs protection of personal credit information; companies can use personal information only for purposes for which the individual has consented and must indicate whether usage is necessary or optional.
  - In practice, individuals in Korea choose to not permit optional usage in the vast majority of instances.

### Initiatives to foster fintech innovation and regulatory adjustments
- “Designated agent system”:
  - Allows fintech firms to partner with banks and offer services on a test basis for up to two years as agents of the bank; at end of period, successful offerings may be sold to the partner bank or continue testing if designated as “innovative financial service.”
- Financial Innovation Support Act and sandbox:
  - Sandbox launched April 2019 (entry into force of the Financial Innovation Support Act).
  - Approved fintech companies permitted to test new financial services subject to regulatory exemptions for up to four years.
- Recent legal amendments to ease obstacles:
  - Lifting the ceiling on ownership stake a bank may have in technology companies (15% previously; otherwise tighter restrictions and requirement to have management role apply) and shortening review process.
  - Allowing securities companies to provide certain payment services (previously prohibited).
  - Allowing financial institutions to store personal credit information and personally identifiable information on cloud-computing servers (previously limited to “non-critical information” and excluded customer information).
  - Allowing securities companies and credit card issuers to send money abroad for retail customers up to a total of $50,000 USD per year per customer (previously only commercial banks could provide such services).
- Anticipated FSC measures to ease requirements for easy payment and simple e-money transfer providers:
  - Allowing a small-sum credit function (currently, all balances with a service provider must be pre-funded).
  - Increasing the deposit limit for balances with service providers up from the current KRW2 million ($1,800 USD).
  - Allowing service providers to handle foreign exchange payment transactions and provide higher loyalty discounts to customers (akin to credit card companies).

### Data protection reform and open banking rollout
- CIUPA amendment proposal:
  - Bill proposed November 2018, pending in the National Assembly.
  - Would permit processing, analysis, and storage of pseudonymized personal information without individual consent for production of statistical information (including commercial purposes).
  - Would permit personal information to be used in more circumstances without individual consent if usage is sufficiently related to the original/main purpose and subject to encryption or other security processes to be stipulated.
- Open banking system:
  - Announced roll-out in 2020.
  - Plan (announced February 2019) to open access to existing bank settlement system so fintech companies and banks can develop payment products enabling customers to access account information and initiate payments across banks with customer consent.
  - Mandatory participation for commercial banks envisioned to replace individually negotiated bilateral agreements.
  - Uniform cap on commission fees charged to service providers by banks to one tenth of current level:
    - Current fee: KRW400 to 500 per transaction.
    - Proposed lowered fees: about KRW40 to 50 for large service providers, and KRW20 to 30 for small- and medium-sized service providers.

*Source: Box 2. New Drivers of Innovation in Financial Services: Case Study of Samsung Pay (excerpt).*

### 24.   The authorities aim for the “open banking system” to serve as an infrastructure open

### 24.   The authorities aim for the “open banking system” to serve as an infrastructure open

### Overview of the Korean “open banking system”
- Designed to be an infrastructure open to all licensed fintech companies and banks to access the systems of other banks in Korea.
- Intended to facilitate the emergence of two new types of payments-related service providers (Interface Providers):  
  - Providers enabling customers to initiate payments from their bank accounts to a beneficiary, bypassing card payment systems.  
  - Providers offering information aggregation services that pull together transaction histories and balances from multiple financial institutions into consolidated dashboards for customers.

### Characteristics of Interface Providers and customer-facing functionality
- Interface Providers can be licensed fintech companies or incumbent banks; commercial banks may compete with fintech entrants in providing interface services.
- From a customer perspective, Interface Providers offer:
  - Better, faster, more user-friendly interfaces to access transaction information.
  - Capabilities to initiate payments from customer accounts at Back-end Banks.
  - Dashboard platforms enabling analyses of spending habits, financial advice, and personalized advertisements or offers.

### Simple e-money transfer services facilitated by the open banking system
- The “open banking system” is expected to facilitate simple e-money transfer services by fintech companies:
  - Interface Providers can use the system to allow customers to generate an electronic currency balance via transfer from their bank account and to redeem balances via transfer to their bank account more efficiently and at lower cost.
  - Simple e-money transfers in that electronic currency move entirely between digital wallets of the Interface Provider and do not make direct contact with Back-end Banks, preventing those banks from tracking or analyzing the individual transactions of their customers.

### Earlier “open API system” initiative and its limitations
- In August 2016, Korean banks launched an “open API system” to facilitate fintech connection to a pool of 16 commercial Back-end Banks via standardized APIs.
- The “open API system” sought to remove the burden of developing multiple incompatible APIs for fintech companies, but challenges remained, including:
  - Access limited to only small fintech firms.
  - High fees charged by Back-end Banks of approximately KRW400-500 ($0.30-0.40 USD) per transaction.

### Design objective vis-à-vis PSD2 (European Union)
- Authorities designed the Korean “open banking system” with goals similar to PSD2: foster competition and innovation in payments services by granting licensed Interface Providers access—subject to customer consent—to account and transaction information held by Back-end Banks.
- Expected effect: facilitate market entry by removing need for individually negotiated agreements between Interface Providers and each Back-end Bank.

Box: PSD2 (summary from source)
- PSD2 broadened payment services regulation, required EU banks to open payment infrastructure and customer data to other banks and payment service providers, and imposed heightened data security standards (including SCA requirements and RTS for secure communication).
- SCA authentication factors require at least two of: something only the user knows; something only the user possesses; something the user is. RTS also require dynamic linking for certain online payment transactions, with proportionality-based exemptions.

### Operational difference from PSD2
- Critical operational difference: PSD2 contemplates direct connection between a bank and a payment service provider or another bank at a customer’s request.
- Under Korea’s model, licensed Interface Providers connect to an interbank settlement system operated by the KFTC, and route transaction inquiries and process transactions through the KFTC-operated payment system, which connects to relevant Back-end Banks.
- The Korean approach leverages existing system processes and mechanisms rather than requiring direct bank-to-provider API connections.

### Stability, security, and oversight measures described by authorities
- Settlement and finality:
  - Transactions made through the open banking system are settled among Back-end Banks the next business day via payment netting by the BoK.
  - Settlement finality among Back-end Banks is guaranteed by a relevant law.
- Insurance requirement for Interface Providers:
  - Interface Providers using the “open banking system” will be required to take out an insurance policy which covers a certain percentage of their daily withdrawal limits (on average 200%, with the prescribed percentage varying across Interface Providers based on their risk profile).
- Security measures:
  - Authorities plan to address system vulnerabilities by creating security guidelines for users and performing periodic reviews and testing.
- Monitoring:
  - Authorities have indicated they will monitor the impact of the “open banking system” on the stability of the overall financial system.

### Legal foundation under development
- Authorities plan to amend the EFTA to:
  - Create a legal foundation for mandating Back-end Banks to open their systems to Interface Providers.
  - Require standardized APIs for Interface Providers.
  - Prohibit discrimination by Back-end Banks against Interface Providers in processing payments (e.g., differences in processing speed and queuing order).
- Amendments to the CIUPA are pending to establish a legal foundation for sharing personal information involved in account information services.

### Market structure, competition, and data implications (Main findings)
- Fintech-driven unbundling:
  - Korea’s fintech development began with unbundling of financial services (e.g., funds transfer, loans, investment management), lowering barriers to entry and increasing competition for customer loyalty.
- Platform evolution:
  - Successful single-service providers are evolving into financial platforms (examples cited: Toss, Kakao Pay, Naver Pay) offering a range of financial services within single smartphone applications.
- Business model dynamics:
  - Payment services often generate low commission revenue and high costs for growth-stage companies, yet large technology companies offer payments to retain users and cross-sell other services.
  - Financial platforms can cross-subsidize payment services through other revenue streams.
- Data accumulation and competitive effects:
  - Interface Providers are beginning to accumulate valuable customer spending and financial position data traditionally held by banks.
  - As simple e-money transfers grow, a larger share of retail payments may use Interface Providers’ proprietary electronic currency systems, reducing Back-end Banks’ visibility into customer transactions.
  - Reduced visibility can hinder Back-end Banks’ ability to monitor linkages and risks and to offer personalized financial products such as credit.
- Legal relaxations and network effects:
  - Parallel initiatives to relax legal restrictions on electronic financial transactions and personal data use, combined with the open banking system, may catalyze network effects for Interface Providers that leverage advanced technology and data.
- Implications for banks:
  - Banks face increasing difficulty maintaining current operating models amid technological change and changing customer expectations.
  - Competition for the direct customer relationship will intensify between incumbent banks and fintech entrants.
  - Displacement risk: fintech Interface Providers collecting and using customer data could displace banks’ direct interaction with customers, potentially reducing deposit “stickiness” and affecting Back-end Banks’ cost of funding and stability.

### Potential financial stability considerations
- The open banking system is characterized as a paradigm shift that transforms a compartmentalized, bank-centric system into a more open and competitive system with greater operational complexity and new interlinkages.
- Uncertainties and risks:
  - Open banking frameworks are early in implementation; effects on consumer demand and market development are unclear.
  - Potential new implications for financial stability exist if large technology companies succeed in payment services—an outcome potentially amplified by legal relaxations on electronic transactions and personal data.

*Source: IMF staff summary of chapter section on the Korean “open banking system.”*

### 40.   Korea’s undertaking of a cross-cutting review of financial sector laws to reform those

### 40.   Korea’s undertaking of a cross-cutting review of financial sector laws to reform those

### Overview and expected benefits of fintech and open banking
- Incumbent Korean banks might adapt and improve digital interfaces and may form partnerships with fintech companies to enhance mobile platforms and increase efficiency of legacy banking processes (e.g., through technologies such as cloud computing, artificial intelligence, and data analytics capabilities).
- Fintech innovations hold potential benefits for users, including by reducing transaction costs, providing greater transparency with simpler financial products, providing greater convenience and efficiency, and enabling tighter controls over spending and budgeting (see ¶9 and Box 2).
- The “open banking system” is expected to enable a wider range of financial services to access account information and initiate payments (see ¶24), anticipated to lower barriers to entry and enable innovation around new functionality (e.g., services for individuals to split monthly pay checks or connect debit cards among their accounts with multiple banks).
- Growth in fintech innovation catalyzed by Korea’s parallel initiatives brings potential benefits but also risks and challenges to customers, banks, and the banking system.

### Short-term operational and reputational risks from implementing the “open banking system”
- Prior to the introduction of the “open banking system,” managing the risk of customer fraud, data breaches, and operational vulnerabilities within their systems was the responsibility of Back-end Banks, who had discretion in selecting partnerships and could negotiate bilateral agreements with risk-mitigating provisions.
- The prescriptive requirements of the “open-banking system,” designed to replace the need for direct contractual relationships between Interface Providers and Back-end Banks, render it more challenging for Back-end Banks to exercise oversight and monitoring over Interface Providers.
- Full participation of all 18 commercial banks in the “open banking system” means that a vulnerability in one Interface Provider could impact the broader financial system.
- The KFTC is charged with preventative risk-control measures (e.g., providing secure open APIs, screening applications to participate in the “open banking system” as Interface Providers, and detecting anomalies in customer activity). Centralized data sharing via the KFTC brings many benefits but also results in a “bigger surface area” for cyber-attacks as more data is shared with more parties, increasing the possibility of data breaches and the importance of effective data management.
- KFTC’s experience in managing security risk and network operations is useful but there is room for further strengthening of the system.

### Design and operational features of the “open banking system” (Box 5)
- Fintech companies can access the Korean “open banking system” as Interface Providers by choosing one “main” Back-end Bank to maintain their accounts and by executing an agreement with the KFTC. Banks may access the “open banking system” as Interface Providers as well.
- Upon being granted access, an Interface Provider can connect, via the KFTC-operated open banking platform system, into all participating Back-end Banks, with the ability to access account and transaction information held by Back-end Banks on their customers upon consent of the customer.
- Transactions among Back-end Banks, in connection with retail transfers initiated through the “open banking system,” are settled on a deferred net settlement basis:
  - When a customer uses an Interface Provider to initiate a transfer, the instruction is routed through the open banking center to the Back-end Banks.
  - The relevant funds are immediately credited to the beneficiary, and the obligations among all Back-end Banks are netted on the following business day and settled by BOK-Wire+.
  - Settlement among Back-end Banks is not final until the net position is settled; unsettled positions accumulate up to the designated settlement time.
- In the medium to long term, authorities will consider allowing qualified fintech payment service providers direct access to the Korean retail payment system, including without relying on a “main” Back-end Bank’s services. To be eligible, fintech providers will have to meet certain requirements in financial soundness and digital capabilities, to be determined. The decision and requirements will be determined after sufficient discussion between the BOK and other relevant organizations.
- Pilot roll-out status:
  - All 18 commercial banks in Korea are participating in a pilot roll-out of the system and opening access to customer accounts and transaction information.
  - In October 2019, the authorities announced the launch of a pilot of the “open banking system” with the participation of the 18 commercial banks in Korea as Back-end Banks.
  - Of those banks, 10 banks also participated on a voluntary basis as Interface Providers, with plans to expand such participation in mid-December 2019 to the remaining eight commercial banks and all non-bank fintech firms that have applied and been approved by the KFTC.
  - The 18 banks are: BNK Kyongnam Bank, Busan Bank, Citibank Korea, Daegu Bank, Jeju Bank, Jeonbuk Bank, K Bank, Kakao Bank, KDB, KEB Hana Bank, IBK, KB Kookmin Bank, Kwangju Bank, NH Bank, SC Bank Korea, SH Bank, Shinhan Bank, Woori Bank.
  - The 10 banks are: NH Bank, Shinhan Bank, Woori Bank, KEB Hana Bank, IBK, KB Kookmin Bank, Busan Bank, Jeju Bank, Jeonbuk Bank and BNK Kyongnam Bank.

### Operational resilience, third-party risk, and data security concerns
- Incompatibilities in the operational processes of Back-end Banks among each other, as well as legacy systems versus Interface Providers with state-of-the-art methods, raise heightened operational risk in the “open banking system.”
- The role of Interface Providers as entryways to Back-end Banks increases complexity and the risk of loss in managing third-party risk and ensuring operational resilience. Interdependences could cause an operational failure (e.g., service suspensions) or cyber incident (e.g., a targeted attack on one participant) to impact multiple financial institutions and potentially the broader financial system.
- The increasing number of parties involved in processing financial information, reliance on information sharing, and trend toward simplification of authentication procedures in payment services expand channels and vulnerabilities that may be exploited.
- Preventative security controls and threat detection measures managed by the KFTC could be complemented by a legal framework addressing resiliency and continuity with coordination among end-to-end participants (Interface Providers, Back-end Banks, the KFTC, and end-users), including:
  - Clear requirements and procedures for outage or breach notification, reporting, and information sharing.
  - Legal certainty and clarity regarding loss allocation, with rules calibrated to incentivize relevant parties to take appropriate action to minimize system risk exposure.

### Medium- to long-term competitive dynamics and systemic risks from big tech and concentration
- Large technology firms can leverage large existing customer bases, brand recognition, and state-of-the-art technology to achieve scale rapidly across different business lines, including financial services; they have significant financial resources and access to capital and funding at lower cost.
- BIS characterization of big tech business models: (D)ata analytics, (N)etwork externalities, and interwoven (A)ctivities, producing a “DNA” feedback loop where more users generate more data, enhancing services and attracting more users (see ¶¶2 and 35).
- Commercial banks, despite large customer bases and one-stop-shop offerings, have not been as effective as big techs in harnessing the “DNA” feedback loop to offer innovative or customized retail payments services at scale.
- Concentration risk may increase among Interface Providers if large technology firms gain significant market share, posing risks to financial stability.
- Risks to banks and market structure effects:
  - Loss of banks’ interaction with customers to Interface Providers can result in loss of customer data and cross-selling opportunities for Back-end Banks, which may become commoditized service providers.
  - Sharing of customer data under the “open banking system” with Interface Providers may further facilitate unbundling, with specialized providers offering services that were previously integrated.
  - Customers’ improved ability to compare fees and charges may erode Back-end Banks’ income and funding. Interface Providers and financial marketplaces like Bank Salad offer platforms to compare account rates and other banking service terms, encouraging more frequent movement of retail deposits and aggressive pricing on loan offers and deposit rates.
  - Higher depositor churn may pressure banks to raise rates to acquire and retain deposits, putting pressure on profitability and increasing liquidity risk.
- These risks are forward-looking in Korea given that the provision of payment services by large technology companies is relatively nascent.

### Policy interaction and need for coordinated, gradual implementation
- Initiatives to encourage intense competition in payment services, introduced in parallel to relaxing legal restrictions for electronic financial transactions and usage of personal data, would be strengthened by a coordinated and gradual approach that prioritizes stability.
- The mutually reinforcing legislative initiatives could facilitate Interface Providers and “big data” business models built on scale; rapid growth at the expense of profitability and long-term sustainability could introduce structural flaws and crowd out new business models.
- Authorities would benefit from close engagement with the Korean competition authority and regular assessment of stability risks, particularly monitoring the effect of large technology firms’ activities on incumbent financial institutions’ ability to generate capital via retained profits.
- The potential for large technology firms to rapidly achieve scale in financial services underscores the need for authorities to stay vigilant of market developments and systemic risk implications.

### Recommendations
- Foster certainty and market confidence in full implementation of the “open banking system,” including formulation of its legal foundation, by giving heightened attention to the increased security and operational risks that accompany increased data sharing and growing connectivity among diverse market players (see ¶42).
- Take a coordinated and gradual approach that prioritizes stability with regard to introducing the “open banking system” and relaxing legal restrictions for electronic financial transactions and the usage of personal data, with regular assessment of financial sector impact (see ¶45).

*Source: IMF staff analysis in the Republic of Korea country report section titled “Korea’s undertaking of a cross-cutting review of financial sector laws to reform those…”*

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_Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1korea2020007.pdf_