"If COVID-19 Doesn't End This Year... Half of Domestic Companies Unable to Pay Interest"(Summary)

Bank of Korea Mid-Year Financial Stability Report

50.5% of Companies Unable to Pay Interest from Operating Profit in Worst Case
Liquidity Shortage of 54.4 Trillion Won in Impacted Sectors like Aviation
458,000 Households Unable to Survive One Year Under Foreign Exchange Crisis-Level Shock

Non-Bank Financial Institutions' Risks Must Be Closely Monitored
Continued Policy Response and Corporate Restructuring Needed for Structural Improvement

[Asia Economy Reporters Eunbyeol Kim, Sehee Jang] If the novel coronavirus disease (COVID-19) crisis continues throughout the year, it is expected that more than half of all companies will be unable to even pay interest with the money they earn. Although this is based on a worst-case scenario assumption, it suggests that while providing policy support, structural improvements such as corporate restructuring are necessary to endure the crisis for a long time. Since the development of a COVID-19 vaccine is still distant and our economy may have to coexist with the virus longer than expected, this assessment was made assuming the 'worst-case scenario.' It also conveys the message that policy responses must be timely and appropriate because if the shock intensifies, the number of companies and households unable to survive even one year could increase consecutively.

According to the 'June 2020 Financial Stability Report' submitted by the Bank of Korea to the National Assembly on the 24th, under the worst-case scenario assuming the COVID-19 shock continues throughout the year, the proportion of companies with an interest coverage ratio below 1 is estimated to reach 50.5%. Last year (32.9%), one in three companies struggled to cover interest payments.

The average interest coverage ratio of companies is also expected to plummet sharply from 3.7 times at the end of last year to 1.1 times. An interest coverage ratio below 1 means that a company cannot even pay interest with its annual operating profit. The debt-to-equity ratio is also projected to surge from 88.8% to 93.1% in the worst case. The proportion of companies with a debt ratio exceeding 200% is expected to reach 40.5%.

Households burdened with debt are also a concern. The analysis shows that if the increase in unemployment reaches the level of the foreign exchange crisis, 458,000 households would not survive even one year. For self-employed individuals, if the sales shock similar to the immediate aftermath of COVID-19 continues, 301,000 households would not last beyond one year. Professor Soyoung Kim of Seoul National University’s Department of Economics analyzed, "If companies cannot pay interest, bankruptcies may follow. For households, especially the self-employed, some who have taken out mortgage loans are at risk."

Meanwhile, the Financial Stability Index (FSI), which indicates the overall stability of the financial system, rose to a crisis level during the first quarter. The FSI reached the crisis level in April (22.3) but has since declined and currently stands at 18.0. The FSI is expressed on a scale from 0 to 100 based on 20 monthly indicators across six sectors affecting financial stability: banks, financial markets, external factors, real economy, households, and companies. It is categorized as normal (below 8), caution (8?22), and crisis (22 or above). Previous times when the FSI entered the crisis stage include the foreign exchange crisis (December 1996?March 1999, peak in January 1998 at 100) and the financial crisis (September 2008?June 2009, peak in December 2008 at 57).

◆Surging Debt, Uncertainty About Where It Will Burst= So far, responses to the economic impact of COVID-19 have been effective. Aggressive 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 surge in loans could burden the financial system. With debts piled up, if a 'weak link' in a specific sector breaks, shocks could cascade.

As of the end of the first quarter, the ratio of household and corporate loans (private credit) to nominal Gross Domestic Product (GDP) reached 201.1%, surpassing 200% for the first time ever. This is the result of rapidly increasing loans amid declining growth rates. Private credit, which recorded a 6% growth rate 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 1,229.2 trillion won, up 11.6% year-on-year.

For companies, the debt levels of sectors severely impacted by COVID-19, such as aviation, shipping, and accommodation and food services, are concerning. The debt ratio of the aviation industry, which was around 667.3% last year, is projected to plunge to -1905.5% under the worst shock scenario, indicating complete capital erosion. Liquidity shortages in related industries are also problematic. Under the basic scenario, the liquidity shortfall is estimated at 30.9 trillion won, and under the worst-case scenario, it could reach 54.4 trillion won. About 30% of this shortfall is attributed to marginal companies.

Household debt also hit a record high of 1,611.3 trillion won. The household debt-to-disposable income ratio rose by 4.5 percentage points year-on-year to 163.1% at the end of the first quarter. The ratio of financial liabilities to financial assets increased 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. Financial institutions have extended loan maturities for small and medium enterprises and small business owners by about six months, but starting in November, as these extended maturities come due, delinquency rates at financial institutions may rise."

◆Monitoring Non-Bank Financial Institutions... Potential Risk Spread Points= So far, the management 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 (321.7 trillion won) by non-bank financial institutions were loans to small and medium-sized corporations and individual business owners. By industry, the proportion of real estate and construction is high at 55.6%, making them sensitive to economic cycles. The proportion of loans with credit ratings below grade 7 among household loans by non-bank financial institutions is also 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 securities or alternative investments, exposing them to market risks. As of the end of March, market risk exposure stood at 1,266.4 trillion won. Since non-bank financial institutions also rely heavily on market funds, a shock to financial markets could lead to liquidity shortages. It is possible to analyze 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 advised, "Non-bank financial institutions could become a transmission path for systemic risk due to the spread of COVID-19. Policy authorities should continuously monitor major risks and make appropriate policy responses."

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