Hidden Delinquency Rates... Will the Fourth Quarter See a Default Bomb Due to Principal and Interest Repayment Deferrals?

Loan Repayment for COVID-19 Affected SMEs and Small Business Owners Postponed by 6 Months
Signs of Delinquency Expected from October in Secondary Financial Institutions and Credit Loans

[Asia Economy Reporter Kwon Haeyoung] Concerns are emerging that from the fourth quarter onward, financial sector insolvencies caused by the six-month principal and interest repayment deferral for small and medium-sized enterprises (SMEs) and small business owners affected by COVID-19 will become visible. The government’s loan principal and interest repayment deferral policy for companies and self-employed individuals, implemented across the entire financial sector, may create an optical illusion that conceals rising delinquency and insolvency rates in financial institutions. Amid worsening domestic economic conditions due to increased unemployment and business closures caused by COVID-19, it is pointed out that from October, when the repayment deferral ends, non-bank financial institutions and unsecured loans could become a trigger for insolvency.

According to the Bank of Korea’s Financial Stability Report on the 20th, the proportion of low-income self-employed borrowers who were delinquent on loan principal or interest payments for more than 10 days stood at 4.1% at the end of the third quarter of 2019, up 0.5 percentage points from 3.6% at the end of 2018. Among them, the proportion of long-term delinquencies exceeding 90 days rose from 1.8% to 2.2% during the same period. Other self-employed individuals with middle to high incomes also saw the delinquent borrower ratio jump from 1.8% at the end of 2018 to 2.2% at the end of the third quarter of 2019.

The financial sector views the government’s directive to all financial institutions to grant principal and interest repayment deferrals to SMEs and small business owners affected by COVID-19 as likely to cause involuntary “evergreening” by financial companies (extending loan maturities to carry non-performing loans forward).

The government issued a common guideline for all financial institutions starting this month, requiring at least a six-month loan maturity extension and interest payment deferral if there is no insolvency such as principal and interest delinquency, capital erosion, or business closure. For personal unsecured loans, if repayment is difficult due to income reduction caused by COVID-19, only interest payments are required, and principal repayment can be deferred for more than six months. Accordingly, opinions suggest that financial institutions’ insolvency will be deferred (extended) due to COVID-19 impacts.

An official from a commercial bank said, “During the principal or interest repayment deferral period, signs of insolvency will not appear, but there is a high possibility that deferred insolvencies will suddenly surface when this program ends. Although it is difficult to gauge the expansion of insolvency caused by COVID-19, since the deferral only postpones the timing of insolvency, the principal and interest deferral measure is being implemented as a form of shared pain and coexistence.”

Compared to banks used by high-credit borrowers, insolvency in the secondary financial sector?such as savings banks, credit card companies, and capital companies, which are mainly used by middle- and low-credit borrowers?is expected to rise noticeably. The interest repayment burden ratio relative to income for low-income self-employed individuals was 23.9% as of the end of September 2019. This means that for every 100 won earned, about 24 won must be paid as interest. The proportion of borrowers whose interest burden exceeds their income is 3.9%.

The key factor for financial institutions’ insolvency is expected to be whether the COVID-19 crisis prolongs. A Financial Supervisory Service official said, “If the COVID-19 situation continues structurally, it will lead to an increase in insolvency beyond simple deferral. However, if COVID-19 subsides around the second half of the year, borrowers who survive may normalize through the principal and interest repayment deferral. The scale of deferred insolvency could vary greatly depending on how much policy funds for SMEs and small business owners are supplied on a large scale and how many small business owners actually apply for the repayment deferral as they try to endure.”

This content was produced with the assistance of AI translation services.