"Interest Rates Rising"... 10% of Loans to Default-Risk Companies and 76 Trillion Won in High-Risk Loans to Self-Employed (Comprehensive)

Private Credit-to-GDP Ratio at 215.5%

Gap Between Household Loans and Real Economy Widens to Highest Since Card Crisis

10% of Corporate Loans at Risk of Default

192,000 High-Risk Self-Employed Households with Weak Repayment Ability…Debt Size of 76.6 Trillion KRW

[Asia Economy Reporters Eunbyeol Kim, Sehee Jang] Due to the COVID-19 pandemic, South Korea’s household debt surged to an all-time high, causing the gap with the real economy to widen at the largest scale since the card crisis. Even compared to the global financial crisis, household debt was found to be at an excessively high level relative to real economic activity. The scale of debt is excessively large considering the reality of our economy. The combined size of private loans, including household and corporate loans, has far exceeded twice the gross domestic product (GDP). A significant portion of the debt has flowed into asset markets such as stocks and real estate, and with interest rates fluctuating, the number of economic agents unable to repay their debts has also increased.

According to the Bank of Korea’s “Financial Stability Report (March 2021)” released on the 25th, the ratio of household and corporate loans (private credit) to GDP at the end of last year was 215.5%, up 18.4 percentage points from a year earlier. The household credit gap (the difference between the household credit-to-GDP ratio and its long-term trend), which indicates the gap between the real economy level and household debt growth, recorded its highest level since the fourth quarter of 2002 (7.4 percentage points), when the card crisis occurred. The household credit gap represents the difference between the normal credit growth rate and the actual growth rate, meaning that recent credit growth rates, including loans, have significantly deviated from the normal trajectory. The corporate credit gap, which shows the gap between corporate debt and the real economy, was also 9.2 percentage points, close to the 10.6 percentage points recorded in the third quarter of 2009, right after the financial crisis.

The credit gap is a debt risk evaluation indicator that shows how much the ratio of private credit (household and corporate debt) to nominal GDP deviates from its long-term trend. The faster the ratio of household and corporate debt to GDP increases compared to the past, the larger the gap becomes. The Bank for International Settlements (BIS) also pointed out on March 3 that Korea’s private credit gap had reached an all-time high. ▶For the article dated March 3, 2021, see BIS: "Korea’s Household and Corporate Debt Risk Level at All-Time High... 'Alarm' Level"

Household debt reached 1,726.1 trillion KRW at the end of last year, up 7.9% from the same period the previous year. Quarterly growth rates gradually accelerated, with 4.6% in Q1, 5.2% in Q2, and 7.0% in Q3 of last year. Corporate loans stood at 2,153.5 trillion KRW at the end of last year, up 10.1% from the end of 2019.

Signs of loan risk are detected in various areas. Corporate loans with a high risk of default exceed 10% of total corporate loans, and the number of self-employed households classified as ‘high-risk households’ due to weak repayment ability reached 192,000. Concerns are rising that loan defaults could materialize if loan interest rates gradually increase as the economy recovers. Professor Sangbong Kim of Hansung University’s Department of Economics said, “Interest rates are likely to rise in the second half of this year, and since loans are directed toward stocks or real estate, borrowers will inevitably suffer if interest rates rise.” Min Jwahong, Director of the Financial Stability Bureau at the Bank of Korea, also stated, “Private debt has flowed into asset markets, causing asset prices to surge and financial imbalances to deepen,” adding, “There is a possibility that credit risks will materialize in vulnerable sectors when government support measures end.”

Additional interest burdens have already appeared. Since July last year, as market interest rates rose, the additional loan interest paid by corporations and households was about 1 trillion KRW. This estimate was made by applying the market interest rate increase of 8.1 basis points (1 bp = 0.01 percentage points) to the outstanding balance of variable-rate loans. So far, the interest burden has not been significant, but if loan interest rates rise in the future, the burden on economic agents could increase further.

Loans to ‘Risky Corporations’ with High Default Probability Exceed 10%

‘Repayment-risk corporations (risky corporations)’ that fail to meet all criteria for interest coverage ratio, debt repayment ratio, and debt ratio accounted for 6.9% as of the end of last year. The risky loans held by these corporations (risky loans) continued to rise, reaching 10.4% of total loans. Corporations under ‘repayment-risk watch’ (watch corporations), which are not at default level but require attention, accounted for nearly 40%.

By industry, the proportion of risky corporations was high in sectors affected by travel contraction and poor face-to-face services, such as airlines (71.4%), shipping (25.0%), and accommodation & food services (22.2%). In the airline industry, 7 out of 10 companies are at high risk of default. The proportion of risky loans was high in sectors with large loan sizes per company, such as machinery equipment and shipbuilding. If interest burdens increase for companies with slow recovery, financial indicators may deteriorate, leading to classification as risky corporations. For example, under the basic scenario where corporate sales growth rate reaches 7.2% this year and overall corporate performance recovers to pre-COVID-19 levels, the proportion of risky loans decreases from 10.4% to 10.1%. However, under the worst-case scenario where the COVID-19 crisis prolongs, performance remains poor, and interest rates rise, the proportion of risky loans could increase to 16.7%.

A Bank of Korea official said, “If average interest costs rise to pre-COVID-19 levels, even financially sound companies could be classified as risky corporations,” and added, “Care must be taken to prevent credit risks in vulnerable sectors from emerging all at once when financial support measures end.”

Corporate interest payment ability is also a key focus. Last year, the average interest coverage ratio of companies was 4.4 times, slightly improved due to falling loan interest rates. However, excluding the electronics sector, the interest coverage ratio dropped sharply to 3.1 times. The proportion of companies with an interest coverage ratio below 1, meaning they cannot cover interest expenses with operating profit, increased from 36.1% in 2019 to 40.7% last year.

On the 25th at 10 a.m., a Financial Stability Situation (March 2021) briefing was held at the Bank of Korea in Jung-gu, Seoul. From the left in the photo: Min-kyu Lee, Head of the Stability General Team; Jwahong Min, Director of the Financial Stability Bureau; Kudo Park, Head of the Stability Analysis Team. Photo by [photographer's name]

192,000 High-Risk Self-Employed Households with Weak Debt Repayment Ability

The number of self-employed ‘high-risk households’ with weak debt repayment ability was 192,000 as of the end of last year. This represents a sharp increase from 109,000 households in March last year, within nine months. ‘High-risk households’ are defined as those with a debt service ratio (DSR) of 40% or higher, indicating a heavy burden of principal and interest repayment, and a debt-to-asset ratio (DTA) of 100% or more, meaning it is difficult to repay debt through asset sales. The debt size held by these households doubled to 76.6 trillion KRW during the same period. This accounts for 6.5% of all self-employed households with debt by number of households and 15.2% by amount. By industry, retail trade households had the highest loan proportion at 18.8% based on financial debt, followed by transportation (15.4%), healthcare (5.4%), and personal services (5.3%).

The financial soundness of all self-employed persons also deteriorated. The DSR of self-employed persons was 38.3% at the end of last year, up 1.2 percentage points from 37.1% at the end of March 2020, despite government principal and interest repayment deferral measures. The loan-to-income ratio (LTI) of self-employed persons rose sharply from 195.9% at the end of March 2020 to 238.7% at the end of December. The debt-to-total assets ratio of self-employed persons increased from 28.5% at the end of March 2020 to 31.4% at the end of last year. Among self-employed persons, those in the highest income quintile saw improvements in financial soundness indicators last year due to rising asset values such as real estate and stocks, but other income groups did not.

A Bank of Korea official said, “The debt repayment ability of self-employed persons has significantly deteriorated due to sales shocks caused by COVID-19,” adding, “Especially for low-income (first and second quintile) self-employed persons, the deterioration in financial soundness due to COVID-19 was more severe than other income groups.” The official continued, “By industry, financial soundness declined in most face-to-face service sectors such as retail, food service, accommodation, transportation, and education services,” and emphasized, “As sales shocks continue and principal and interest repayment deferrals end, there is concern that the deterioration of debt repayment ability among self-employed persons will accelerate. It is necessary to consider supplementary measures such as installment repayment of deferred principal and interest when the deferral period ends.”

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