"Debt Increased While 'Putting Out Urgent Fires'... Could It Come Back as a Boomerang?"

Bank of Korea Mid-Year Financial Stability Report
Need to Respond to Prolonged COVID-19 Scenario

Surge in Loans May Pose Significant Burden on Financial System
Close Monitoring of Non-Bank Financial Institution Risks Required

[Asia Economy Reporters Eunbyeol Kim and Sehee Jang] The Bank of Korea assumed the 'worst-case scenario' to assess the financial stability situation because the novel coronavirus infection (COVID-19) and the Korean economy may have to coexist longer than expected. Vaccine development is still distant, and external uncertainties such as the US-China trade dispute are also prevalent. The report also conveyed a message that policy responses must be timely and appropriate, as a growing number of companies and households may not survive even a year if the shock intensifies.

◆Surging debt, uncertain where it might burst= The response to the economic impact of COVID-19 has been effective so far. The active monetary easing by the government and the Bank of Korea has helped households and companies overcome the crisis. The problem arises if the crisis prolongs, as the rapidly increasing loans could burden the financial system. If a 'weak link' in a specific sector breaks amid the accumulated debt, shocks could cascade.

According to the 'June 2020 Financial Stability Report' released by the Bank of Korea on the 24th, the ratio of household and corporate loans (private credit) to nominal Gross Domestic Product (GDP) exceeded 200% for the first time in history, reaching 201.1% as of the end of the first quarter. While growth rates have been declining, loans have surged rapidly. Private credit, which recorded around 6% last year, increased by 7.6% in the first quarter. The increase in corporate loans was particularly notable. At the end of the first quarter, corporate loans amounted to KRW 1,229.2 trillion, up 11.6% year-on-year.

For companies, the debt levels of those severely impacted by COVID-19, such as airlines, shipping, and accommodation and food services, are concerning. The debt ratio of the airline industry, which was around 667.3% last year, is projected to plunge to -1905.5% under the worst-case shock assumption, indicating complete capital erosion.

Household debt also reached a record high of KRW 1,611.3 trillion. The household debt-to-disposable income ratio stood at 163.1% at the end of the first quarter, up 4.5 percentage points year-on-year. The ratio of financial liabilities to financial assets rose by 0.5 percentage points year-on-year to 47.7%.

Professor Sangbong Kim of Hansung University said, "If companies' profits do not recover and liquidity is insufficient, they will eventually issue bonds, but there may be no buyers for those corporate bonds." He added, "Financial institutions have extended loan maturities for small and medium-sized enterprises and small business owners by about six months, but starting November, as these extended loan maturities come due, delinquency rates at financial institutions could rise."

◆Non-bank financial institutions require close monitoring... could become a risk contagion point= So far, the soundness indicators of financial institutions, especially general banks, remain favorable. The concern lies with non-bank financial institutions. Mutual finance, insurance, credit finance companies, securities firms, and other non-bank financial institutions are more likely to be exposed to risks first if the crisis prolongs. As of the end of March, 90.1% of corporate loans (KRW 321.7 trillion) by non-bank financial institutions were loans to small and medium-sized corporations and individual business owners. By industry, real estate and construction accounted for 55.6%, making them sensitive to economic cycles. Among household loans by non-bank financial institutions, the proportion of loans with credit ratings below grade 7 was 9.0%, much higher than banks' 2.2%. The delinquency rate on non-bank household loans in the first quarter was 1.92%, higher than banks' 0.27%.

Non-bank financial institutions often invest in overseas listed securities or alternative investments, exposing them to market risks. As of the end of March, market risk exposure stood at KRW 1,266.4 trillion. Since non-bank financial institutions also rely heavily on market funds, a significant shock in financial markets could lead to liquidity shortages. This could trigger a vicious cycle: 'shock to non-bank financial institutions → insolvency of banks and financial holding companies → contraction of financial support for households and companies → further deterioration of the real economy.' A Bank of Korea official stated, "Non-bank financial institutions could become a transmission channel for systemic risks arising from the spread of COVID-19," advising, "Policy authorities should continuously monitor major risks and make appropriate policy responses."

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