[Bank of Korea Financial Stability Report] "Household and Corporate Credit Risk Underestimated... Credit Losses May Reach 67 Trillion Won"

[Asia Economy Reporter Kim Eunbyeol] Despite the shock of the novel coronavirus infection (COVID-19), the base interest rate was lowered to an all-time low, and with massive liquidity boosting corporate stock prices, it has been evaluated that credit risk was not sufficiently reflected in financial market price variables.

It is analyzed that if the economic growth rate continuously falls below the forecast and a gap adjustment occurs between the real economy and finance, household and corporate credit losses could reach 67 trillion won.

On the 24th, the Bank of Korea introduced the results of a stress test reflecting the impact of delayed economic recovery on different sectors in the "2020 Second Half Financial Stability Report" submitted to the National Assembly. The Bank assumed a scenario where the economic growth rate continuously falls below the Bank’s forecast, credit risk awareness expands, asset prices decline, and financial imbalances are adjusted.

The test results estimated that credit losses on corporate and household loans would approach 67 trillion won. This means credit losses, expected to be around 32 trillion won, would more than double. Corporate loan defaults were found to increase significantly more than household loans, and due to asset price declines and credit spread widening, financial institutions’ capital ratios could also drop substantially.

Under the scenario set by the Bank of Korea, the default rate for corporate loans is expected to rise from 1.36% to 2.29%, an increase of 0.93 percentage points. Credit losses are also expected to increase by 26.8 trillion won, from the existing 21.3 trillion won to 48.1 trillion won.

The same applies to household loans. The default rate on household loans is expected to rise from 0.96% before the shock to 1.32%, and credit losses are expected to increase by 5.2 trillion won, from 13.5 trillion won to 18.7 trillion won. This means that if economic recovery is delayed more than expected, losses caused by economic agents such as corporations and households failing to repay debts will increase.

For financial institutions, it is expected that regulatory levels will be met even if growth rates fall short of expectations. However, capital ratios are expected to decline significantly, especially among securities firms and insurance companies.

A Bank of Korea official explained, "In the case of securities firms and insurance companies, the proportion of securities in their holdings is high at around 50-60%, so if a shock hits the financial market, market losses are greater compared to other industries."

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