Debt rising too much, are we too insensitive... BIS warns "Korea's debt level nearing 'alert'"

Impact of COVID-19 on Livelihood Loans, Yeongkkeul, and Debt Investment Continues
BIS-Compiled Private Debt Risk Level Indicator
Q1 at 9.4%P... Sharp Rise from Last Year's 6.6%P
Exceeding 10%P Triggers 'Warning' Level

Financial Authorities Conduct Loan Inspections but
Hard to Tighten Regulations Amid Difficulties for Low-Income Citizens Due to COVID-19

[Asia Economy Reporter Eunbyeol Kim] As corporate and household debt in South Korea rapidly increases, the risk level of private debt has moved one step closer to the 'alert' stage. With the prolonged COVID-19 pandemic causing incomes to steadily decline, the pace of debt growth is expected to accelerate, signaling the need for caution.

According to the Bank for International Settlements (BIS) on the 14th (local time), South Korea's credit-to-GDP gap in the first quarter was 9.4 percentage points, up 2.8 percentage points from 6.6 percentage points in the fourth quarter of last year. Compared to 1.0 percentage point in the first quarter of last year, it rose by 8.4 percentage points in just one year. This is the highest figure since the fourth quarter of 2009 (11.2%), during the aftermath of the global financial crisis.

The credit gap is a debt risk assessment indicator that shows how much the ratio of private credit (household and corporate debt) to nominal Gross Domestic Product (GDP) deviates from its long-term trend. The gap widens as the share of household and corporate debt in GDP increases faster than past trends. According to BIS, a credit gap exceeding 10 percentage points is classified as the 'alert' stage, between 2 and 10 percentage points as the 'caution' stage, and below 2 percentage points as the 'normal' stage. South Korea's credit gap began to rise from the end of 2017 and entered the caution stage at the end of June last year. If it exceeds 10 percentage points on an annual basis this year, the debt level will enter the 'alert' stage for the first time in 11 years since the financial crisis.

COVID-19 Driven Livelihood Loans, 'Yeongkkeul', and 'Debt Investment'

The main reason for the soaring risk level of private debt is that households and companies affected by the COVID-19 pandemic are sustaining themselves through loans. The problem is that not only loans to endure tough living conditions but also loans for investment are rapidly increasing. According to the Bank of Korea, household loan balances at banks increased by 11.7 trillion won compared to the end of the previous month, reaching 948.2 trillion won last month. Among the increased household loans, the sharp rise in other loans (credit loans) indicates that the number of people 'borrowing to invest' is growing.

Yoon Ok-ja, Director of the Financial Market Department at the Bank of Korea, said, "There was demand to cover insufficient housing funds with credit loans," adding, "The increase in individuals entering the stock market and the public offering subscription frenzy also seem to have influenced this." Corporate loans also increased by 5.9 trillion won last month, bringing the balance to 961 trillion won.

Following this debt growth trend, the ratio of private debt to GDP rose to 201% at the end of the first quarter. This is the first time the private debt to GDP ratio has exceeded 200%. According to BIS data, South Korea ranked 13th out of 43 countries in terms of private debt to GDP ratio. The household debt to GDP ratio (95.9%) ranked South Korea 7th.

Are Bank Asset Soundness and Resilience at Risk?

Historically, most financial crises in various countries occurred when the credit gap exceeded 10 percentage points. As debt burdens grow larger than income, the number of people unable to repay loans increases, leading to a higher proportion of non-performing loans and rising delinquency rates, which inevitably destabilizes banks and other financial institutions. According to BIS, as of the end of the first quarter, only five countries had a larger credit gap than South Korea. Hong Kong was the highest at 24.6%, followed by Chile (16.1%), Japan (14.1%), Switzerland (11.6%), and Singapore (9.5%). South Korea's credit gap was even larger than those of emerging countries with heavy debt burdens such as Thailand, Mexico, Malaysia, and Argentina, prompting some voices calling for managing loan sizes.

Financial authorities have also begun to assess the situation. However, it is difficult to know the exact purpose of credit loans, making it challenging to tighten credit lines indiscriminately. Premature regulation could further burden low-income groups or self-employed individuals who were hit hardest by COVID-19.

It is also necessary to re-evaluate whether banks' asset soundness and resilience remain at a healthy level. According to the Bank of Korea's June Financial Stability Report, the ratio of non-performing loans at general banks was 0.46%, down 0.09 percentage points from the same period last year. The Basel III total capital ratio (15.3%) was lower than at the end of last year (15.89%) but still well above regulatory standards for all banks. A Bank of Korea official stated, "We will continuously monitor domestic and international risks and actively fulfill our role as the lender of last resort if credit tightening worsens." The Bank of Korea will update and release the Financial Stability Report at the end of this month.

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