From Next Month, Legal Maximum Interest Rate Set at 20%... Ordinary People Hanging on the Loan Cliff (Comprehensive)

Top 10 Major Loan Companies See Borrowers and New Loans Halved in 2 Years
Low-Credit Borrower Loan Ratio Drops from 64.5% to 52.8% at These Firms
Illegal Loan Usage in Japan Increases Sevenfold Due to Interest Rate Cuts
Experts Say "Flexible Application Needed to Match Market Economy Conditions"

[Asia Economy Reporters Kwangho Lee, Hyojin Kim, Seungseop Song] Concerns are rising that about 320,000 people could face a 'loan cliff' as the legal maximum interest rate is lowered from 24% to 20% per annum starting next month on the 7th. Among the 2.39 million people who used loan products with interest rates exceeding 20% per annum, 316,000 are likely to be unable to extend their loans or be rejected, potentially turning into 'financial refugees.' In particular, even loan companies, the last bastion of the formal financial sector, are expected to either give up their business or tighten loan screening, leading to a surge in low- to medium-credit borrowers being pushed into illegal private loans.

The Paradox of a Well-Intentioned Policy... Maximum Interest Rate Reduction Fuels Illegal Private Loans

According to the 'Large Loan Company Status Survey' submitted by the Financial Supervisory Service to the office of Yoon Chang-hyun, a member of the National Assembly's Political Affairs Committee from the People Power Party, the number of borrowers and new loans at the top 10 loan companies at the end of last year were 720,000 and 1.3088 trillion KRW, respectively, which is about half compared to the end of 2018 (1.34 million borrowers, 2.6119 trillion KRW). Compared to the end of 2019 (980,000 borrowers, 1.6539 trillion KRW), it decreased by 260,000 borrowers and 345.1 billion KRW.

This is the result of businesses giving up or tightening loans due to deteriorating profitability caused by the reduction of the legal maximum interest rate. In fact, Sanwa Loan, ranked second in the loan industry, Taegang Loan ranked fifth, and U& I Loan ranked eighth have stopped issuing new loans and are only conducting collection operations. Leadcorp, the third-largest loan company, is preparing a stepping stone to become a formal financial company through the acquisition of a capital company.

The problem is that among their personal credit loans totaling 3.4547 trillion KRW, 95.7% (3.3046 trillion KRW) are loans with an annual interest rate of 20% or higher. The reason why loan companies have many high-interest loans exceeding 20% per annum is due to their cost structure. Currently, the average funding cost for loan companies is about 6%. Since their main customers are low-credit borrowers (grades 7 to 9), bad debt costs (unrecoverable amounts) are about 10%, and operating expenses such as management fees and loan broker commissions are 7% of the loan amount. The total cost is about 22-23% of the total loan amount. The loan industry voices that the interest rate must be at least 20% for the business to break even.

However, loan companies have been continuously reducing the proportion of loans to low-credit borrowers. In 2018, excluding those among the top 10 companies that did not conduct new business, low-credit customers accounted for 64.5% of the total. This proportion slightly decreased to 63.3% in 2019 and sharply dropped to 52.8% last year. Looking at individual companies, those that secured more than 70% low-credit borrowers two years ago have disappeared, and most maintain a range of 40-60%. There are even companies where the proportion of low-credit loans is only 14.2%.

Similar side effects were found in research data analyzing the impact of lowering the maximum interest rate from 27.9% to 24% by the Korea Institute of Financial Services. According to a survey conducted in March targeting low-credit borrowers and loan companies, the number of new loan applications and approved customers sharply decreased over time after the interest rate reduction. New credit loans also saw a 41.9% rate of re-loans focused on existing customers, an increase of 23.9 percentage points compared to the previous year, and 16.3% (an increase of 9.7 percentage points) reported stopping all credit loans. If the maximum interest rate is lowered to 20%, 36.4% of companies said they would consider selling or closing their business, and 26.2% said they would downsize operations through workforce reductions and restructuring.

The damage ultimately falls on vulnerable groups with low credit ratings and difficult circumstances. Despite the reduction in the maximum interest rate, illegal private loan usage remains high among older people, those with uncertain income sources, and those with poor credit. Vulnerable groups who entered illegal private loans due to rejection by loan companies were enduring excessive interest rates. Among survey respondents, 69.9% were paying interest rates exceeding the legal limit, and 30% were paying interest exceeding the principal within one year. An estimated 12.3% of respondents were burdened with interest rates exceeding 240% per annum.

Japan Also Faces Side Effects of Interest Rate Reduction, While South Korean Politicians Call to "Lower Rates Further"

The aftereffects of lowering the maximum interest rate are also evident in Japan, which implemented a similar measure 10 years ago. Japan sharply lowered the maximum interest rate under the Investment Law from 29.2% to 20% per annum starting in June 2010. According to the report 'Market Changes Over 10 Years After Strengthening Regulation of Japan's Moneylenders' by the Credit Finance Research Institute, the number of registered moneylenders as of March last year was 1,647, a 73.3% decrease compared to March 2009. The Japan Financial Services Agency reports that the number of illegal moneylender users has increased more than sevenfold since 2010.

Nevertheless, in the political arena, there are continuous calls to further drastically lower the legal interest rate. Lee Jae-myung, the leading presidential candidate within the Democratic Party of Korea and Governor of Gyeonggi Province, argued last month via his Facebook account that the legal interest rate for loan companies should be lowered to the 11% range. His logic is that "the base interest rate is 0.5%, but forcing ordinary people to pay 20% interest just because they are poor is against the spirit of the constitution."

Min Hyung-bae, a Democratic Party member of the National Assembly's Political Affairs Committee, has introduced the 'Partial Amendment to the Interest Restriction Act' and the 'Partial Amendment to the Act on Registration of Loan Business and Protection of Financial Users,' which set the maximum interest rate as the lower of 15% per annum or 20 times the base interest rate. Currently, with a base interest rate of 0.50%, 20 times equals 10.0%. Other Democratic Party members, including Kim Nam-guk, also proposed an amendment to the Interest Restriction Act last year to allow the maximum interest rate to be set by presidential decree within a range not exceeding 10% per annum.

Yoon, a member of the National Assembly, advised, "If the price of money, i.e., interest rates, is sharply lowered, suppliers (financial companies) will inevitably stop selling the loan products." He warned, "We must not ignore recent precedents where government price interventions (rapid minimum wage increases) resulted in negative effects (job losses)." He added, "Although financial authorities are expanding mid-interest loans and strengthening policy financial products like Sunshine Loans, there are limits. More practical supplementary measures must be prepared."

Experts have suggested reconsidering the one-sided policy of lowering rates. Professor Kim Dae-jong of Sejong University's Department of Business Administration pointed out, "For small business owners or self-employed people, the important thing is not cheap interest rates but whether they can borrow within the formal financial sector." He suggested, "A flexible application method that adapts to the current market economy situation, where the maximum interest rate has been continuously lowered, should be introduced." Oh Jung-geun, Chairman of the Korea Financial ICT Convergence Society, criticized, "The most concerning group due to the maximum interest rate reduction is the financially vulnerable. I believe the 20% reduction plan should be re-examined from scratch even now."

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