Regulatory and Supervisory Blind Spots... Mutual Finance Becoming a Hotbed of Speculation

LH Scandal Reveals Mutual Finance Moral Hazard
Loose Regulations and Lax Screening Turn It into a 'Speculation Playground'
Concerns Rise Over Potential Insolvency and Deteriorating Soundness

The LH (Korea Land and Housing Corporation) speculative loan scandal starkly reveals the current state of mutual finance, which has deviated so far from its founding and existential meaning of mutual aid among members that it has fallen into a 'moral hazard.'

Due to relatively lax loan regulations, mutual finance has degenerated into a 'speculative playground' for outsiders, and its soundness indicators, such as delinquency rates, have not escaped a worsening trend, raising concerns about large-scale insolvency.

◆Member Mutual Finance? The Reality Is Quite Different = A particularly highlighted issue in the LH scandal is the serious damage to the value of mutual finance operations centered on member mutual aid. The case of Nonghyup, the largest mutual finance institution, fully reflects this reality.

According to the financial sector on the 22nd, as of June last year, the proportion of loans to members among the total loans of individual Nonghyup cooperatives was only 28.6%. The rest were quasi-members (31.5%), who pay a small fee and join as long as they have an address in the area without farming, and non-members (39.9%), who are outsiders.

The loan ratio between members and non-members in mutual finance varies by sector. Credit unions must execute two-thirds of their loans to members. In Nonghyup's case, the member loan ratio is half, but since loans to quasi-members and deemed members are also included, more than half of the loans are executed to people who do not farm.

In the case of Buksiheung Nonghyup, which was the loan window for LH employees, the loan growth rate from the first half of 2019 to the first half of last year was 7.3%. However, the loan growth rates for quasi-members and non-members were 11.8% and 12.0%, respectively, far exceeding the overall loan growth rate.

According to Yoon Chang-hyun, a member of the People Power Party, out of the 35.7 trillion won increase in mutual finance loans last year, 30.7 trillion won were non-residential secured loans such as land and commercial buildings, excluding apartments or houses. This suggests that a significant portion of the loan increase may have been misused for land speculation by quasi-members and non-members, similar to the LH speculative loan cases.

◆Will Expanding the Proportion of Member Loans Be Effective? = The financial authorities intend to induce an increase in the proportion of loans to members in mutual finance loans. Specific measures being discussed include lowering the member weighting and raising the non-member weighting when calculating the loan-to-deposit ratio (LDR), which currently ranges from 80% to 100%. Currently, the weights for members and non-members are both 1, but the plan is to differentiate the weights to increase the lending capacity for members. It is also known that an option to keep the member weighting unchanged while only increasing the non-member weighting is being considered.

The problem is that such measures need to be effective on the ground, but given the current structure, this is not expected to be easy. The loan-to-value ratio (LTV) for non-residential secured loans in mutual finance is up to 70%. Moreover, because the value of mutual aid based on mutual help is emphasized, a uniquely lax screening culture is deeply rooted. Commercial banks apply an LTV of around 60%, and their loan screening is considerably stricter compared to mutual finance.

Another factor contributing to the moral hazard in mutual finance is the dispersion of management and supervision authorities across institutions such as the Financial Services Commission, Ministry of the Interior and Safety, Ministry of Agriculture, Food and Rural Affairs, Ministry of Oceans and Fisheries, and Korea Forest Service. Professor Ha Jun-kyung of Hanyang University's Department of Economics pointed out, "Since mutual finance also plays the role of a general financial institution, it is necessary to revise regulations so that they can have unified legal provisions."

Loan Volume Grows but Quality Deteriorates

◆Soundness Already in the Red... Serious Accumulation of Potential Insolvency = The soundness problem of mutual finance is also recognized as serious. This can act as a factor increasing dependence on non-residential secured loans to non-members. According to the Financial Supervisory Service, as of the end of June last year, the delinquency rate of mutual finance loans was 2.02%, up 0.31 percentage points from 1.71% at the end of 2019. The delinquency rate entering the 2% range is the first time in six years since 2014.

In Nonghyup's case, net income, which was 1.4751 trillion won in the first half of 2018, shrank continuously to 1.365 trillion won in the first half of 2019 and 1.2989 trillion won in the first half of last year. Meanwhile, the loan balances of agricultural and fisheries cooperatives, forestry cooperatives, and credit unions steadily increased from 240.605 trillion won in 2015 to 277.921 trillion won in 2016, 309.383 trillion won in 2017, 335.2 trillion won in 2018, 352.376 trillion won in 2019, and 387.557 trillion won last year.

As a result, while the total loan volume increases, the delinquency rate also rises, leading to a solidified trend of deteriorating overall quality and worsening profitability. A financial sector official explained, "It is true that mutual finance actively pursued non-residential secured loans to non-members to resolve such structural difficulties."

The current regulations allow a certain extent of non-member loans in mutual finance, considering the nature of mutual finance, which would find it difficult to survive solely on member-targeted finance. This is also the background for criticism that mutual finance has become a 'regulatory blind spot.' Professor Kim Tae-gi of Dankook University's Department of Economics analyzed, "There was a regulatory blind spot because it was a special-purpose bank."

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