Unlikely to Further Worsen?

As of the end of Q1 2011, Korea's household debt amounted to 801.4 trillion won, an 8.4% increase year-on-year. When the liabilities of petty merchants are included, the total reaches 950 trillion won. Meanwhile, personal financial liabilities have recently been confirmed to have topped 1,000 trillion won during the first quarter of this year. With the situation as it is, Korean households are under pressure to repay more interest for their loans, with The Bank of Korea also raising the key rate.

According to recent data from the central bank, personal financial debts, which cover those of households, one-man businesses and nonprofit organizations in the private sector, totaled 1,006.58 trillion won as of the end of Q1, 949 trillion of which constituted non-interest payments.

The aggregate increased 11.7 trillion won in that quarter. Though it is less than that of Q4 2010, which stood at 27.7 trillion won, it was still a marked increase year-on-year. During the same period last year, the accrual stood at 9.6 trillion won.

In the first quarter of 2011, the sector saw the size of its financial assets increase 35.9 trillion won to reach 2,212.4 trillion won. As of March 31, the asset-to-debt ratio of the sector was maintained at the level of 2.33, the second-highest ever following the 2.36 posted in Q3 2007. “The bigger nation's economy gets, the bigger both its financial assets and liabilities become”, said an executive from The Bank of Korea, adding, “What we need to focus on is the fact that the asset side swelled more than the other.” During the same period, the country's total financial asset holdings grew 3.2%, touching 10,630.7 trillion won. The number broke the 10,000 trillion mark in the second quarter last year and has been on a growth track ever since.

“Though the No. 1 goal of our interest rate policy is definitely the stabilization of consumer prices, it is highly effective also as a countermeasure to snowballing household debt”, said The Bank of Korea governor Kim Choong-soo on June 15 during a Strategy & Finance Committee meeting at the National Assembly. He continued, “For sure, we regard such liabilities as a very important part of the equation of our policy.” He also remarked that, although he has pointed out the gravity of the problem for a long time and the necessity of a sort of counterbalance, it is unlikely to result in serious consequences immediately.

“For approximately 7% of all households, debt is over 40% of their income,” he commented adding, “There should be some microeconomic measures because the figure has to be limited, and the interest rate will have to be stabilized macro-economically,” he said, It signals that the key rate is poised to be raised soon in order to ensure that the household debt problem is not further worsened. It was in this context that governor Kim said a prolonged low-interest policy tends to end up with more liabilities.

“The level of household debt is truly worrisome, with the real estate side alone exceeding 800 trillion won and the total overall topping 1,000 trillion won”, said professor Jo Myeong-rae of Dankook University's School of Urban Planning and Real Estate Studies. According to him, the size of the liabilities is so heavy as to potentially affect the real economy sector.

“As of now, the problem does not appear that grave as our economic growth rate is more than 0%, yet it could get ugly at any time given our economy's high dependence on exports and vulnerability to oil prices and foreign exchange conditions,” he warned. “If the real economy takes a hit, housing prices and household income could both plummet, creating a secular stagnation similar to that of Japan.” In order to fend off such a situation, he suggests the government takes direct control of the gross amount of liabilities as well as the debt-to-income (DTI) ratio. In response, governors of The Bank of Korea and local commercial banks who attended the meeting indicated that some action will be taken shortly, along with assistance given to vulnerable members of society.

On June 17, the central bank's governor met with the heads of ten local city banks. During the meeting, all of them remarked, “In the wake of the global financial crisis, major nations have taken steps to adjust household debt, and it seems that now is the time for us to follow.” They added, “We may be well-advised to heed the possibility of the problem developing into the instability of low-income and heavily-indebted households, rather than financial institutions, considering factors such as the low default rate and loan-to-value (LTV) ratio and banks' high bad debt reserves.” The group did not forget to mention the necessity of backup measures for the underprivileged so as to prevent them from experiencing any further difficulties during the process.

According to what they said, loan takers with low credit ratings may move from the banking to the non-banking sector if regulations on household loans are further tightened, placing a larger interest burden on themselves. The importance of the non-banking sector's lending risk management was emphasized in this vein. Their diagnosis was that real estate prices have to be stabilized, while the disposable income of households must rise.

Meanwhile, some of the participants expressed the opinion that the problem is unlikely to worsen for the time being. Their reasons for this included that the degree of household debts is not that high vis-à-vis the local economic size; the personal debt-to-asset ratio has fallen to pre-crisis levels while household debt reparability has risen, and financial companies have enhanced damage preparations.

However, the governor of the central bank expressed concern on June 10, when the Monetary Policy Committee (MPC) raised the key rate by a quarter of a percent. The governor said, “Currently, some 7% of households are experiencing a hard time redeeming loans, and the problem is that those without solvency are interested in borrowing money.” He added, “Though there is no doubt that the matter is a serious one, it is also a fact that it can be controlled rather well by the government, with relevant ministries able to learn how to tackle it.”

MPC chairman Kim Seok-dong is another who has stressed an aggressive response to household liabilities. “Although the problem is not beyond our control yet, we will deal with it preemptively in order to inhibit instability factors that could stem from the lending structure”, he recently said, adding, “As macro-economic environments should come into play to keep the issue at hand in check, we will pace the household debt increase and strengthen our financial risk management while improving the wobbly lending structure characterized by variable rate and non-installment redemption following a grace period.”

Kwon Hyeok-se, who is at the helm of the Financial Supervisory Service, also commented that his agency will be more committed to the management of household lending risks with the key rate expected to continue rising. On June 14 at the National Policy Committee of the National Assembly, he said, “We are going to revise upward the minimum bad debt allowance of financial companies, while strengthening our supervision on groups whose default rate and bad loan growth are higher.”

He explained, “The current household loan increase in the non-banking sector, such as mutual finance companies, which is led mainly by ordinary people, not the rich, could make the situation worse if interest rates rise.” According to him, although local households' debt-to-income level is slightly higher than the OECD average, it is unlikely that a fast exacerbation of the situation in a short period of time will occur as the default rate is limited to 1.8%.

Meanwhile, the Financial Supervisory Service is planning to further regulate credit card firms' push to grow.

“The competition is speeding up and credit card loans, which pose more burden on the general public, have been swelling recently”, the FSS chairman said at the committee meeting, adding, “By means of enhanced supervision, we will prevent the race from leading to a surge in high-risk assets and household liabilities.”

Specifically, the agency intends to start a special inspection of credit card firms heavily engaged in the competition and less adept at risk management. Those companies which have issued more cards to non-qualifiers are to be subject to stern reprimands. In step with the movement, the government is to present a comprehensive plan in order to better address the household debt issue.