[Q&A] 3.5%P Reduction in Mid-Interest Loans for Medium and Low Credit Borrowers by Industry

[Asia Economy Reporter Kwangho Lee] Financial authorities are increasing mid-interest rate loans for middle- and low-credit borrowers and lowering loan interest rates. The plan is to supply about 32 trillion won to approximately 2 million people this year and about 35 trillion won to about 2.2 million people by 2022.

On the 25th, the Financial Services Commission announced the "Mid-Interest Rate Loan System Improvement Plan" as the third follow-up measure following the reduction of the statutory maximum interest rate (from 24% to 20%).

A financial authority official explained, "This plan focuses on expanding the supply of mid-interest rate loans to middle- and low-credit borrowers, inducing a reduction in loan interest rates through the use of digital technology and market competition, and absorbing some low-credit borrowers who might be excluded from the loan market due to the statutory maximum interest rate reduction into mid-interest rate loans."

The following is a Q&A on the Mid-Interest Rate Loan System Improvement Plan.

- What is a mid-interest rate loan, and which range is referred to as the interest rate gap?

▲ Although there is no exact definition of mid-interest rate loans, they generally refer to personal credit loans with interest rates around 10% targeting middle-credit borrowers. When the mid-interest rate loan activation policy was first implemented in 2016, the interest rate gap was considered to be in the 7-15% range, but due to the continued low interest rate trend, it is now understood that the interest rate gap appears in the 6-14% range.

- Does the activation of mid-interest rate loans exacerbate household debt problems?

▲ The mid-interest rate loan market is a market failure caused by a lack of evaluation capability for middle-credit borrowers, resulting in an inability to form appropriate loan interest rates. The basic purpose is to resolve the difficulty middle- and low-credit borrowers face in seeking high-interest loans in the 20% range due to the absence of a mid-interest rate market around 10%. This measure aims to induce an expansion of mid-interest rate loan supply through market autonomy and is unrelated to the worsening of household debt problems.

- What is the difference between mid-interest rate loans and policy-based low-income financial services?

▲ Policy-based low-income financial services enable low-interest loans through separate funding sources (such as dormant deposits and lottery fund contributions), whereas mid-interest rate loans supply appropriate interest rate loans based on market mechanisms without additional funding, which is the fundamental difference.

- Why have Saeitdol loans been supplied mostly to high-credit borrowers so far?

▲ Saeitdol loans are guaranteed products by private financial companies (Seoul Guarantee Insurance), and if the default rate is high, issues such as deteriorating profitability and increased insurance premiums arise, which increases the incentive to supply to high-credit borrowers. In particular, savings banks reduced Saeitdol loan supply after the second half of 2017 due to rising delinquency rates, but the high proportion of Saeitdol loans supplied to middle- and low-credit borrowers by savings banks was one of the main causes of the delinquency rate increase. For internet-only banks, the main cause was the expansion of supply to high-credit borrowers (existing grades 1-3) after launching Saeitdol loans.

- Considering the purpose of expanding loan supply to middle- and low-credit borrowers, is the current operation of Saeitdol loans a failure?

▲ In the past, the mid-interest rate market was criticized for difficulty in customer selection and high risk due to information asymmetry, making it difficult for individual financial companies to enter. Accordingly, Seoul Guarantee Insurance launched a product to share loss risks with financial companies and act as a "primer" for the mid-interest rate market. Saeitdol loans are evaluated to have contributed to expanding mid-interest rate loan supply to middle- and low-credit borrowers by regulated financial institutions. Especially, they have faithfully played the role of a primer for the mid-interest rate loan market in the secondary financial sector, such as savings banks, which had difficulty selecting customers due to information asymmetry about borrowers.

- Why was the Saeitdol loan credit score criterion newly established at the lower 30% (previously grade 5 or below)?

▲ The new credit score criterion for Saeitdol loans was established to minimize the use of Saeitdol loan funds by high-credit borrowers rather than middle- and low-credit borrowers. Previously, there was no credit grade requirement among Saeitdol loan eligibility conditions, resulting in an excessive proportion of low-risk high-credit borrowers (grades 1-3). In particular, internet-only banks supplied 66.4% of Saeitdol loan execution amounts to grades 1-3, which was problematic.

- What is the future operational direction of Saeitdol loans?

▲ Saeitdol loans were designed as a transitional product to form the mid-interest rate loan market since their launch in 2016. Recently, the annual supply of private mid-interest rate loans has increased to 11.3 trillion won, indicating that Saeitdol loans have faithfully played their intended role as a primer for the mid-interest rate loan market. However, due to this system reform, there may be some reduction in Saeitdol loan supply or issues such as increased insurance premiums due to rising default rates. Therefore, the supply amount of Saeitdol loans will be gradually adjusted considering the mid-interest rate loan market situation in the future.

- Why has private mid-interest rate loan supply by banks been sluggish so far?

▲ Banks have continuously supplied credit loans to middle- and low-credit borrowers, but there has been an aspect of omission in the current system's mid-interest rate loan aggregation.

So far, only non-guaranteed credit loans that meet pre-disclosure, supply more than 70% to credit grades 4 or below, and satisfy certain interest rate requirements have been recognized as private mid-interest rate loans and given regulatory incentives. However, banks have had almost no incentives based on mid-interest rate loan performance, resulting in insufficient launch of dedicated products and pre-disclosure. Therefore, although banks supplied about 14.4 trillion won annually in credit loans to middle- and low-credit borrowers with grades 4 or below, only 1.9 billion won was counted as private mid-interest rate loans because most did not meet pre-disclosure requirements.

- Why limit the private mid-interest rate loan supply target to the lower 50% of credit scores?

▲ To ensure mid-interest rate loans are concentrated on middle- and low-credit borrowers, all non-guaranteed credit loans below the interest rate cap by industry, supplied to the lower 50% of credit scores (previously grade 4 or below), will be recognized as mid-interest rate loans and given regulatory incentives under the system reform.

- Why was the weighted average interest rate requirement for private mid-interest rate loans abolished?

▲ Previously, regulatory incentives were given only to mid-interest rate loan products meeting certain requirements by industry. In addition to the interest rate cap, a weighted average interest rate requirement was set for each product, and only those meeting it were classified as mid-interest rate loans. This reform changes the incentives from being product-based to being based on loans to middle- and low-credit borrowers, setting only the interest rate cap and removing the weighted average interest rate requirement.

- Why was the private mid-interest rate loan interest rate cap lowered as it is now?

▲ It was necessary to reflect factors such as market interest rate decline due to the base rate cut considering the recent COVID-19 economic situation and policy interest rate reduction factors due to the statutory maximum interest rate cut (from 24% to 20%). Also, although regulatory incentives are given proportionally to the scale of mid-interest rate loans by industry, there have been calls for adjustment due to excessive benefits to some industries amid market environment changes. In particular, savings banks have recently seen a rapid increase in supply meeting private mid-interest rate loan requirements due to market interest rate declines.

- Is there concern about a reduction in private mid-interest rate loan supply due to the lowering of the interest rate cap?

▲ With the lowering of the interest rate cap among private mid-interest rate loan requirements, the scale of loans classified as mid-interest rate loans by industry is expected to shrink somewhat. However, since the private mid-interest rate loan requirements are merely conditions for providing regulatory incentives, it is difficult to conclude that the scale of mid-interest rate loans will decrease based on this. Mid-interest rate loans generally refer to loans in the 6-14% range for middle-credit borrowers, but the interest rate cap requirement was set to clarify the scope of regulatory incentives.

- How will the expansion of mid- and low-credit borrower loan supply by internet-only banks be induced?

▲ Currently, the scale of mid-interest rate loan supply by internet-only banks is large, but the proportion of loans to middle- and low-credit borrowers is insufficient. Plans to implement inducement measures to expand this are underway.

- Why is it necessary to advance the credit evaluation model of savings banks?

▲ Since savings banks mainly provide loans to middle- and low-credit borrowers, reliable credit evaluation of borrowers is an essential factor for industry development. However, savings banks' credit evaluation systems and loan interest rates have not sufficiently reflected these demands. To improve this, plans are in place to advance credit evaluation systems to incorporate various non-financial information and individual borrower characteristics.

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