Bank of Korea's Debt Warning: First Mention of "Selective Support for Sustainable Companies"

Looking into the Financial Stability Report

Possibility of Default on Rapidly Increasing Debt Expands
Need to Control Loan Growth Speed Highlighted
Household Debt Also Analyzed for Increased Medium- to Long-Term Risks

[Asia Economy Reporter Kim Eunbyeol] The Financial Stability Report published by the Bank of Korea on the 24th draws attention for its different tone compared to the three reports released earlier this year. While the reports issued up to September this year emphasized responses to the COVID-19 pandemic, such as stating "there was a policy effect from liquidity supply" or "there is a need to prepare for potential losses," this time the report advises the need to manage rapidly increasing debt. It suggests that since unlimited monetary and fiscal policy support cannot continue indefinitely after the COVID-19 crisis, proactive management is necessary.

"Selective Support for Companies with High Long-Term Viability"

A notable point in the Bank of Korea's '2020 Second Half Financial Stability Report' is the warning about private debt exceeding twice the size of South Korea's economy, along with the mention of 'selective support.' This is the first time the Bank of Korea has referred to 'selective support' in its financial stability reports since the COVID-19 outbreak.

Economic agents such as companies and households have been able to survive this year through government and Bank of Korea support, but they also face the problem of excessive debt growth. The Bank of Korea sees an increasing possibility that the rapidly growing debt could become non-performing. Therefore, it believes there is a need to consider measures to control the pace of loan growth while implementing selective support targeted at specific groups.

The Bank of Korea evaluated in the report that "if accommodative financial support measures continue for a long time, they may delay corporate restructuring and hinder the efficient allocation of financial resources." It added, "Financial support measures should be gradually normalized in line with improvements in corporate financial soundness and business conditions, and selective support should be provided mainly to companies with high viability."

This shift in policy stance is based on the expectation that the shock from COVID-19 will ease next year and corporate sales will recover. The Bank of Korea's forecast for next year's growth rate is 3.0%. Under this scenario, liquidity shortages among companies are expected to be partially resolved. Assuming continued government financial support and a recovery in corporate performance next year, the Bank of Korea estimates that about 2.5% of companies will experience liquidity shortages. The shortage amount is also expected to decrease to 600 billion KRW, down from this year's annual estimate of 1.4 trillion KRW. Lee Min-gyu, head of the Bank of Korea's Stability Analysis Team, said, "If corporate sales recover and financial support continues, it can be seen as creating a liquidity buffer." However, he explained that abruptly stopping support would be risky. In a pessimistic scenario where COVID-19 continues to spread and corporate sales shrink through next year, liquidity shortages could increase to 4.2 trillion KRW. If financial support is also halted in this case, the shortage could rise to 7.7 trillion KRW, affecting 7.0% of all companies with deteriorating liquidity.

The Bank of Korea advises that support should focus on companies experiencing temporary liquidity shortages due to COVID-19 and those with high viability. The proportion of companies unable to cover interest payments with operating profits in the first half of this year (interest coverage ratio below 1) rose to 42.4% of all companies. If this situation persists for more than three years, these companies risk becoming marginal firms.

2 out of 10 Households Have Debt Over Three Times Their Income

Regarding household debt, the Bank of Korea also sees increasing medium- to long-term default risks. The report expresses concern over the household debt-to-GDP ratio exceeding 100% for the first time. According to the Bank of Korea's analysis, the average loan-to-income ratio (LTI) of all borrowers reached 225.9% at the end of the third quarter, up 8.4 percentage points from the end of last year. This means the average debt size is about 2.26 times the income. The proportion of borrowers whose debt exceeds three times their income also reached 23.6%.

So far, borrowers with household loans have not shown a reduced ability to repay debt. This is thanks to the government and financial sector continuously extending loan maturities and lowering loan interest rates. The debt service ratio (DSR) relative to income in the third quarter was 35.7%, showing a downward trend since the end of 2019 (39.6%), indicating that the effectiveness of these measures may diminish. In particular, vulnerable borrowers who are multiple debtors with low credit and low income, as well as those aged 60 and above, may face increased repayment burdens. The Bank of Korea advises, "To curb excessive growth in household debt, it is necessary to strengthen risk management of household loans and consistently maintain a strict macroprudential policy stance."

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