Skyrocketing

The gravity of the problem is huge. Household debt exceeded 800 trillion won in Q1 for the first time ever, running to 892 trillion by September. Between the first two quarters of 2011, the household loan balance increased 2.2% to reach 876.3 trillion won. When sales on credit are included, the figure totaled 993 trillion at the end of Q2.

Fortunately though, this uptrend subsided somewhat in November, due in part to loan regulations introduced by financial authorities. According to a report by The Bank of Korea regarding financial market movements that month, consumer credit in the banking sector stood at 1.3 trillion won, a substantial decrease from October’s 3.1 trillion won. The total consumer loan balance at the end of November was tentatively calculated at 741.2 trillion won.

Increase Especially Sharp in Non-banking Sector

Still, the upward movement in the non-banking sector continues. The household loan increase there the same month reached 2.6 trillion won, slightly up from the previous month’s 2.5 trillion won. Meanwhile, the balances at insurance and mutual finance companies grew at a similar pace, implying that an increasing number of people resorted to insurance policy loans instead of bank loans because of the government’s lending restrictions.

“Though the pace of debt increase slowed down a bit owing to the authorities, a balloon effect occurred at some financial companies, such as insurers, with them lending more than before,” said an industry expert, adding, “The effect led to higher lending rates and added to the burden on borrowers. One of the worrying repercussions is that low-income earners with low credit scores will lean more on the non-banking sector in an attempt to compromise their financial soundness and consumption affordability.”

An official at the Financial Services Commission recently remarked, “Though the rate of household loan increase in Q3 is lower than usual, we will continue to monitor the situations tightly, while exercising more effort to keep the non-banking sector’s consumer credit at an appropriate level.”

Worsening Situation Likely to Damage of Entire Economy

To compound the matter, lending rates have soared in recent months. The current average rate in the banking sector has jumped from 5.35% to 5.86% since late last year. Household interest payments alone are estimated at 50 trillion won for 2011, equivalent to 4.8% of the country’s 2010 GNI.

This rising interest burden is highly problematic in that it can bring about shrinking domestic consumption. If one’s income remains still but repayments go up, the natural reaction is to tighten the purse strings and cut down on spending.

In actuality, the income of the majority of Korean households is showing no signs of growth. The consumer debt-to-GDP ratio is no less than 80% these days, 15% higher than the OECD average. In addition, the debt-to-disposable income ratio currently stands at 158%.

“Undoubtedly, consumer credit expansion can pose various threats to the national economy,” commented a financial analyst, adding, “Such household peril chips away at the overall financial system without our realizing it, and then delivers staggering blows to the economy as a whole. The recent savings bank shutdown and numerous cases of non-performing project financing loans are just such cases.”

Large Number of Potential Bad Loans Due 2012

With circumstances as they are, 2012 is expected to see the climax of the household debt crisis due to the large portion of loans that will mature next year. In particular, those with repayment capacities deemed less than sufficient, approximately 26.6% of all mortgage loans, have to clear their liabilities next year. For the group in question, the ratio of loan balance to annual income is at least 400%, with that of loan balance to security amount higher in some areas than others -- 33% for residents in the Gangnam area, 40% for Seoul excluding Gangnam, 49% for the capital area and 50% or higher for the rest of the country.

“That group of people is feeling more and more pinched, but the capital-area housing market remains in the doldrums, meaning their loans can create bad debt in the near future,” said a Hyundai Securities analyst. “The consumer credit issue will definitely be one of the hottest buttons of the Korean economy in 2012.”

Meanwhile, loans in the non-banking sector taken out by those with low credit ratings accounted for 56% of all loans as of the end of June, increasing 3% in just 18 months. In addition, 57% of the group were indebted to both the banking and non-banking sectors.

“This year’s household debt increase can be attributed to the rise in housing lease prices, inflationary pressure affecting the cost of living, and interest cost reduction following the maintenance of low interest rates, etc.,” said a researcher at Woori Investment & Securities. He added, “The proportion of the non-banking sector’s mortgage loans, which are mostly for households with low repayment capacities, is on the decline, while that of credit loans is on the rise, lowering household debt repayment ability across the board. The recent debt increase is more about living expenses than housing purchases. The former purpose accounted for 48.4% of total residential mortgages in the first half of 2011. The credit loan growth rate has surpassed the pace of mortgage growth since the first half of 2009.”

Forward-looking Measures Should Be in Practice

The aftermath of the crisis has not been limited to the household side. As such, authorities would be well-advised to seek more aggressive measures in order to stamp problems down in advance.

“Since most household loans are on a short-term floating rate basis at present, things can go from bad to worse once the government raises the key rate for the sake of curbing inflation,” remarked an expert, asking the government to manage such risks more prudently. He urged individual households and financial institutions to be more wary and heedful, too. “Unaffordable loans should not be made from the get-go and lenders should not offer a loan if it is not to be borne properly. Lending criteria needs to become stricter.”

However, the most effective and fundamental solution is helping people earn enough income. No matter how improved the lending structure is and how tight regulations are, the debt crisis cannot be solved if people cannot cover their daily expenses with their own earnings. Efforts should be made so that less and less households turn to borrowing as their last resort. To that end, welfare benefits need to be available for more and inflation should be kept at the minimum. The effect will be redoubled if relevant policy measures are put in place to revitalize the job market.