Will Accumulating Buffer Capital in Banks Alleviate Household Loan Concentration Risk? (Comprehensive)

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

[Asia Economy Reporter Park Sun-mi] Expectations are growing that the ‘Countercyclical Capital Buffer for the Household Sector,’ which will be introduced in the banking sector in the second half of this year, will effectively manage 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 the introduction of 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 Company Supervision Regulations and Enforcement Rules, aiming for implementation in the second half. 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 expands during economic booms but accumulates vulnerabilities such as default risks, which cause actual defaults during economic downturns. Therefore, financial authorities judged that it is necessary to establish an incentive system to reduce default risks in advance by imposing additional capital accumulation obligations on banks. This judgment was influenced by the need to establish an incentive system that can prevent fund concentration phenomena in specific sectors such as households and real estate.

The method calculates the final additional capital accumulation ratio for each bank differentially by considering the basic accumulation ratio set by the authorities (0 to 2.5%) and the individual bank’s household loan ratio (0 to 100%). Although the maximum limit is capped at 2.5%, penalties will be applied to ensure enforcement by restricting dividend payments, share buybacks, and performance-linked bonuses if banks fail to fulfill the additional capital accumulation obligation.

Within the industry, considering Korea’s relatively low economic situation and the heavy burden of household debt relative to income, the policy to manage the growth rate of household loans is seen as justified. While requiring banks that have significantly increased household loans to accumulate more capital may be burdensome, it is an unavoidable choice by financial authorities for total volume management, given that the household loan growth rate 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, requiring 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 the COVID-19 pandemic and other factors.

Korea Institute of Finance: "Environment Ready for Introduction of Countercyclical Capital Buffer for Household Sector"

Seobyeong-ho, Senior Research Fellow at the Korea Institute of Finance, 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 concentration risk indicators related to the countercyclical capital buffer for household debt 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 countercyclical capital buffer for household debt?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 countercyclical capital buffer for the household sector 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 the mandatory accumulation of 1% additional capital 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 risks caused by the concentration of bank loans. It is a useful system when household loans surge amid uncertain economic forecasts. Banks with insufficient capital adequacy raise related interest rates due to capital cost burdens, which helps mitigate concentration risks."

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