[Bank of Korea Financial Stability Report] "Delay in Corporate Restructuring, Possibility of Asset Price Overvaluation"

15.3% of Companies Have Debt Ratios Exceeding 200%

4 out of 10 Companies Have Interest Coverage Ratios Below 1

Delinquency Rate of Vulnerable Borrowers Increases by 2.0 Percentage Points When Interest Rates Rise

High Possibility of Asset Price Overvaluation... Significant Decline in Housing Prices Possible

[Asia Economy Reporters Eunbyeol Kim, Sehee Jang] The Bank of Korea’s warning about the skyrocketing private debt was largely driven by concerns that if a ‘trigger’ such as an interest rate hike is pulled, the accumulated debt could become a ‘time bomb’ for an economic crisis. Since the COVID-19 pandemic, due to low interest rates and other factors, household and corporate debt has grown to more than twice the size of the country’s gross domestic product (GDP). Many have invested in real estate, stocks, and cryptocurrencies (virtual assets) using borrowed money, so if the asset bubble bursts, the debt could shake the financial system.

In particular, the Bank of Korea specifically mentioned that if interest rate hikes materialize, the burden on vulnerable borrowers, including not only households but also companies, could increase. Since an interest rate hike is expected within this year, this is interpreted as a preemptive warning message to economic agents. Professor Donghyun Ahn of Seoul National University’s Department of Economics said, "If non-performing companies are not restructured, problems could erupt in marginal companies," adding, "The Bank of Korea issued a warning message about 3 to 4 months ahead of the interest rate hike."

"Prolonged Financial Support Delays Corporate Restructuring"

According to the ‘2021 First Half Financial Stability Report’ released by the Bank of Korea on the 22nd, the proportion of companies with debt ratios exceeding 200% increased from 12.4% at the end of June 2020 to 15.3% at the end of last year. This is the highest level in seven years since 2013 (15.7%). Although the overall corporate debt ratio fell from 81.1% to 77.2% during the same period, the proportion of companies struggling with debt ratios exceeding 200% actually increased.

The number of vulnerable companies unable to cover interest expenses with operating profits is also steadily rising. Analyzing 2,520 companies, the Bank of Korea found that the proportion of vulnerable companies with an interest coverage ratio below 1 was 39.7%, nearly 40%. This means that 4 out of 10 companies cannot cover their interest expenses with operating profits. In particular, the proportion of companies with negative interest coverage ratios due to operating losses increased from 28.9% to 32.6%. The scale of loans to self-employed individuals also surged to 831.8 trillion won as of the end of March. Especially, the proportion of high-interest loans increased, worsening the quality of loans.

The problem is that if the vulnerable state of companies persists for a long time, it becomes difficult for them to return to normal, and the rate of bankruptcy conversion also rises. This is why the Bank of Korea emphasized the need to normalize the exceptional financial support measures in the report. The Bank stated, "If financial support for companies is prolonged, it may delay corporate restructuring."

Park Jongseok, Deputy Governor of the Bank of Korea, said at a press briefing that day, "I think it is an issue that needs to be continuously monitored to comprehensively assess corporate competitiveness and sustainability." He advised, "If corporate restructuring is excessively delayed, it risks lowering South Korea’s growth potential. The government should carefully consider and respond to the desirable direction of corporate restructuring in response to industrial structural changes."

Households: High Possibility of Loan Delinquency in Vulnerable Sectors When Interest Rates Rise

Household debt, which reached 1,765 trillion won at the end of the first quarter this year, is also a concern. Especially, when interest rates rise, loan delinquency is likely to increase mainly among vulnerable borrowers. During the interest rate rising period (end of Q4 2016 to Q1 2019), delinquency rates among vulnerable borrowers rose sharply.

During this period, the delinquency rate of vulnerable borrowers increased by 2.0 percentage points, while there was no change in the delinquency rate of non-vulnerable borrowers. The delinquency rate of the high-DSR (debt service ratio) borrower group, whose total debt service ratio exceeds 70%, also rose by 0.3 percentage points when interest rates increased. The Bank of Korea stated, "There is a risk that credit risk will increase further once various financial support measures expire," and added, "Financial institutions need to establish and implement lending strategies to prevent a sharp increase in delinquencies in vulnerable household sectors amid changing domestic and external conditions."

High Possibility of Asset Price Overvaluation... Significant Decline in Housing Prices Possible

The Bank of Korea noted that while the rise in asset prices after COVID-19 partly reflects expectations of economic recovery after the crisis, risk appetite has strengthened across the asset market, making it highly likely that some asset prices are overvalued. In the report released that day, the Bank stated, "Housing prices, especially in the Seoul area, are overvalued when evaluated through major statistical indicators such as long-term trends and price-to-income ratio (PIR)."

It also said, "In a situation where financial imbalances have accumulated, deleveraging may occur in response to domestic and external shocks, causing housing prices to fall sharply," and "The downside risk of housing prices has significantly expanded since the first quarter of last year due to accumulated financial imbalances." The elevated housing price level relative to income and accumulated credit leverage have acted as downward pressures on housing price growth.

Regarding stocks, the risk premium (excess return over risk-free assets such as government bonds) has decreased compared to the past, indicating increased risk appetite, but the price-to-earnings ratio (PER) relative to earnings per share remains low compared to major countries. For corporate bonds, the spread of corporate bond yields over government bonds is below the long-term average, suggesting that risk appetite for bond investments may have increased compared to the past.

For cryptocurrencies, since there is no underlying cash flow such as stock dividends and no significant recent changes in the possibility of intangible benefits, the Bank found it difficult to find reasonable grounds to explain the sharp rise in cryptocurrency prices after COVID-19.

The Bank of Korea said, "If asset price overvaluation continues, it increases the possibility of large-scale price adjustments due to domestic and external shocks, undermining financial stability and macroeconomic stability and acting as a factor that expands asset inequality." It added, "Although asset investment belongs to individual economic activities, their collective results affect financial stability and the macroeconomy, so continuous attention is needed regarding the accumulation of financial imbalances due to private credit expansion and asset price increases."

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