[Lee Jong-woo's Economic Reading] Financial Institutions That Performed Well Amid the COVID-19 Crisis

Status and Outlook by Institution
Banks, Loan Stability Up with Policy Support
Securities Firms, Sufficient Resilience for Real Estate PF
Insurance Industry Must Prepare for Prolonged Low Interest Rates

As the economy worsened due to the novel coronavirus infection (COVID-19), concerns about the stability of financial institutions grew. It was feared that large-scale insolvencies could occur in financial institutions, similar to the global financial crisis. Fortunately, six months later, no significant problems have arisen in domestic or international financial institutions.

The six major U.S. banks have announced their second-quarter earnings. Net profits decreased by 61% compared to the same period last year. The cause of the profit decline was the increase in loan loss provisions, which rose 37% compared to the first quarter and 633% compared to the same period last year. A notable point is that banks set aside more provisions than the actual loan losses. For example, JP Morgan's actual loan losses amounted to only $1.6 billion, but it set aside $8.9 billion in provisions, exceeding the actual losses by more than five times. This reflects the anticipation of many future losses due to the economic slowdown, with preemptive recognition of bad debts.

There are two main concerns for U.S. banks. One is credit card delinquencies, as rising unemployment reduces household income, increasing the likelihood of card payment defaults. The other is commercial real estate. The commercial mortgage delinquency rate has already risen to 4%, and since COVID-19 has caused problems in leasing commercial buildings, delinquencies are expected to increase further. Although the spread of the disease is causing difficulties for U.S. financial institutions, the situation does not yet seem as severe as during the financial crisis.

What is the status of our financial institutions?

Banks have not experienced significant changes yet. Since economic activity weakened from March due to COVID-19, it is not yet time for asset quality to become a problem. For problems to arise, borrowers must be unable to access cash, and that point has not been reached. Even considering these constraints, it is judged that loan loss provisions for our banks will not increase significantly in the near future. As of the end of June, the ratio of loans overdue by more than one month at domestic banks is only 0.33%. Considering that the average delinquency rate for banks in advanced countries is 2-3%, this is a very favorable level. Compared to the same period last year, it has decreased by 0.09 percentage points, maintaining the downward trend before COVID-19. By scale, the delinquency rate for small and medium enterprises is 0.59%, and for self-employed individuals, it is 0.37%, both declining for eight consecutive months. The credit card delinquency rate, a leading indicator of bank delinquencies and accessible even to those with low credit ratings, is also lower than in the first quarter of last year, indicating that problems in banks are unlikely in the near term.

The increased stability of bank loans is due to banks having dealt with high-credit customers over the past several years. Additionally, the government implemented COVID-19 financial support worth 180 trillion won, especially allowing repayment of existing loans and obtaining new loans at ultra-low interest rates worth 12 trillion won, which helped prevent an increase in delinquency rates.

Despite the favorable situation, financial instability has not completely disappeared. Household debt remains a psychological burden. According to the International Institute of Finance (IIF), as of the end of last year, the household debt-to-GDP ratio in South Korea was 95.1%, up 3.9 percentage points from a year earlier. The growth rate is the second fastest among 34 regions worldwide, including the Eurozone. Both the scale and growth rate are high, indicating that the household debt of about 1,600 trillion won could cause problems at any time.

Looking at the composition of household debt, there is some reassurance. The proportion of those aged 60 and over responsible for household debt decreased from 37% in 2012 to the low 30% range currently, while the proportion of economically active people aged 30 to 50 increased. By credit rating, more than 50% of bank loans are made to high-credit borrowers. By income, households with annual incomes over 80 million won hold loans amounting to 750 trillion won, accounting for half of the total. This suggests that the likelihood of household debt suddenly causing problems is low.

Insurance and securities face issues with investment product defaults and low interest rates rather than loans.

In the first half of the year, securities firms struggled due to defaults in equity-linked securities (ELS) and private equity funds. Among these, ELS became particularly problematic when domestic and international stock prices dropped more than 30% in March, triggering large margin calls on securities firms that issued index futures. Considering that the outstanding balance of ELS issued by securities firms is 50 trillion won, the margin calls likely exceeded 3 trillion won at that time, but the subsequent stock price rise has largely resolved the margin shortfall.

Another issue for securities firms is real estate project financing (PF). This involves providing funds or guarantees to real estate developers and has been a major revenue source for securities firms over the past several years. Before COVID-19, funds provided were extended upon maturity, so there were no problems, but since March, extensions have failed, and securities firms have occasionally had to absorb these products themselves. The current scale of real estate PF for securities firms is estimated at about 16 trillion won. After reaching a record high of 16.7 trillion won in March, the scale has decreased due to reduced new guarantees and credit and liquidity enhancements reducing existing guarantees. As of the end of last year, the outstanding balance of real estate PF was less than 30% of securities firms' equity capital. Even in the worst case, securities firms could absorb all real estate PF without problems. Compared to liquid assets, there is ample room, so securities firms' assets do not appear to have problems after COVID-19.

Insurance companies are struggling due to low interest rates caused by COVID-19. If market interest rates continue to decline, insurers will incur losses equal to the difference between the high guaranteed rates of previously sold products and current investment yields. For products sold with a guaranteed 5% return in the past, current rates are about 1%, resulting in an annual loss of 4%. This led to large losses and closures of insurance companies in Japan in the past. We are now facing a similar reality. In the first half of last year, life insurers' investment yields fell below their funding costs by 0.2 percentage points for the first time ever. Since interest rates are now even lower, losses may have increased. Insurers have offset these losses with bond price increases due to falling rates, but with rates so low, it will be difficult to compensate for losses going forward. Although COVID-19 has worsened insurers' conditions, the low-interest-rate-induced insolvency is a long-term issue. The possibility of future interest rate increases should also be considered.

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