Will the Introduction of Buffer Capital in the Banking Household Sector Alleviate Fund Concentration?

Introduction of Household Sector Countercyclical Capital Buffer System Scheduled for Domestic Banks in the Second Half of This Year
Amendments to Banking Supervision Regulations, Enforcement Rules, and Financial Holding Company Supervision Regulations, Enforcement Rules Underway

[Asia Economy Reporter Park Sun-mi] Expectations are growing that the ‘Countercyclical Capital Buffer for the Household Sector,’ to be introduced in the banking sector in the second half of this year, will be effective in managing household loans. This is based on the judgment that it can alleviate the risk of concentration in household loans amid the intensifying fund concentration in specific sectors such as households and real estate. The rapid rise in household debt relative to disposable income and the ratio of housing prices to gross domestic product (GDP) indicates that the environment for introducing the system is already sufficiently established.

According to financial authorities on the 3rd, the countercyclical capital buffer system for the household sector is scheduled to be introduced in the domestic banking sector in the second half of this year. The Financial Services Commission is pushing forward revisions to the Banking Supervision Regulations and Enforcement Rules, as well as the Financial Holding Companies Supervision Regulations and Enforcement Rules, aiming for implementation in the second half of the year. The core of the system is to require banks to accumulate additional capital at a rate of 0 to 2.5% within a maximum period of one year, considering the increase in household loans in the banking sector.

Household debt tends to expand during economic booms but accumulates vulnerabilities such as default risks, which can lead to actual defaults during economic downturns. This has led to the judgment that an incentive system is needed to prevent fund concentration phenomena in specific sectors such as households and real estate.

Within the industry, considering Korea’s relatively low economic conditions and the heavy burden of household debt relative to income, the policy to manage the growth rate of household loans is seen as justified. Although requiring banks that have significantly increased household loans to accumulate more capital ratios may be a burden, it is an unavoidable choice by financial authorities for overall volume management, given that the household loan growth rate has reached 10.8% (as of the end of March).

Previously, in January 2018, the authorities announced a plan to reform capital regulations in the financial sector, including the introduction of the countercyclical capital buffer system for the household sector, which requires banks to accumulate up to 2.5% of common equity capital for household loans. However, the system has not yet been officially introduced due to situations such as the COVID-19 pandemic.

Korea Financial Research Institute: "Environment Ready for Introduction of Countercyclical Capital Buffer System for Household Sector"

Seo Byung-ho, Senior Research Fellow at the Korea Financial Research Institute, diagnosed, "Recently, amid the COVID-19 pandemic and other factors, the growth rates of GDP and disposable income have slowed, while the growth rates of household debt and housing prices have remained high, causing the indicators related to concentration risk in the household debt countercyclical capital buffer to rise. It is judged that the environment for introducing the countercyclical capital buffer system for the household sector is ready."

In fact, the key indicator for determining the accumulation ratio of the household debt countercyclical capital buffer, the difference between household credit and GDP, was 5.9 percentage points at the end of last year, which is 3.5 times the level during the global financial crisis (1.7%). While the average monthly disposable income per household increased by 2.3% last year, household credit increased by 7.9%, so the ratio of household debt to disposable income is estimated to have risen from 152.8% at the end of 2019 to an even higher level at the end of 2020.

There are also successful cases abroad where the introduction of the household sector countercyclical capital buffer in the banking sector has been effective. In Switzerland, the growth rate of bank mortgage loans, which was 5.2% and 4.6% in 2011 and 2012 respectively, fell to 4.2% after mandatory additional capital accumulation of 1% was introduced in February 2013. Subsequently, when the accumulation ratio of the mortgage loan countercyclical capital buffer was raised from 1% to 2% in early 2014, the growth rate of bank mortgage loans further declined to 3.6% in 2014 and 2.6% in 2015.

Research Fellow Seo explained, "The countercyclical capital buffer for the household sector was designed to manage concentration risk caused by the concentration of bank loans. It is a useful system when household loans surge amid uncertain economic outlooks. Banks with insufficient capital adequacy tend to raise related interest rates due to the burden of capital costs, which helps mitigate concentration risk."

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