Moody's Investors Service says that the 53.7% year-on-year fall in net profits recorded for FY2013 (January-December) by the Korean banking sector is in line with its expectations. Key drivers behind the decline were lower margins, higher provisions and impairment losses. Commercial banks and regional banks saw their net profits fall 29.5% and 9.8%, respectively, while policy banks suffered a fall of 134.2%. Policy banks recorded a total net loss of KRW 0.7 trillion, compared with a net profit of KRW2 trillion in 2012. Pre-provision profits in the sector declined 16.2% year-on-year, also in line with our expectations. "We believe these figures reflect that regional banks enjoy more stable core deposits, and thus are better able to protect their net interest margins (NIM). In addition, credit costs are rising among policy banks, as they fulfill their role in restructuring companies in various highly cyclical sectors", says Sophia Lee, a Moody's Vice President and Senior Analyst. Lee was speaking on the release of a new sector comment entitled "Korean Banks: Decline in Net Profits Is in Line with Expectations". System-wide net interest income declined 8.3% to KRW34.9 trillion. The decline mainly reflected ongoing pressure on NIM from weak credit demand and the Bank of Korea's (BOK) 25bps reduction in its policy rate in May 2013 in an already low interest rate environment. "The 23bps decline in NIM is also in line with our expectations. Signs that NIM is stabilizing are emerging, with quarterly NIM improving 4bps to 1.84% in Q4 2013," adds Lee. Meanwhile, provision expenses were at the high end of Moody's estimates. Provision expenses, including contingent credit reserves, rose 5.9%, equating to credit costs of 81bps. The increase reflects a rise in pressures on asset quality from a challenging operating environment. However, Moody's expects this number to be revised upwards, by an estimated 3bps, due to fraudulent loans case at KT ENS (unrated). The case prompted the banks involved to set aside additional provisions and push credit costs above our expectations. Non-operating losses increased to KRW1.8 trillion in 2013 from KRW0.7 trillion in 2012. This development reflects weaker performance and greater losses at associated companies, which are accounted for as equity method affiliates. Losses were concentrated at companies in which policy banks had acquired partial ownership via loan-to-equity swaps, when those companies were undergoing restructuring.