[Zombie Company Warning] Vulnerable Firms Unable to Pay Even Low Interest Rates ↑... Nightmare of Chain Bankruptcies

Zombie Company Warning Amid Rapid Increase in SME Loans in the Financial Sector

[Asia Economy Reporter Park Sun-mi] Since the COVID-19 pandemic, corporate loans have expanded rapidly, raising concerns about insolvency, particularly among marginal companies. Four out of ten companies are unable to cover even their interest expenses with their earnings, leading to forecasts that if the base interest rate rises and COVID-19 financial support ends, a wave of so-called ‘zombie companies’ going bankrupt will be inevitable. The market fears that if restructuring of marginal companies is delayed, the interest rate hike period could trigger a chain reaction of ‘repayment burden → wave of bankruptcies → financial sector insolvency,’ escalating into a systemic crisis.

According to the Bank of Korea and financial authorities on the 25th, corporate loans from domestic banks (including commercial, specialized, and foreign banks) reached 1,006.6 trillion won at the end of the first quarter of this year, up 10.9% compared to the same period last year. The corporate loan growth rate, which was around 5% before the COVID-19 outbreak in 2019, has exceeded 10% since the second quarter of last year due to funding demand to overcome COVID-19 and financial support measures by policy authorities, maintaining double-digit growth for four consecutive quarters.

In particular, unlike large corporations that can raise funds smoothly through direct financing in the capital market, the loan growth among small and medium-sized enterprises (SMEs), which face difficulties in raising funds, has been remarkable. As of the first quarter of this year, loans to large corporations from all financial institutions amounted to 205.7 trillion won, increasing by only 5.4% year-on-year, whereas loans to SMEs surged by 16.3% to 1,193.4 trillion won.

The problem is that as SME loans surge, signs of insolvency are becoming more evident. Among 2,520 companies disclosing financial statements last year, 39.7% had an interest coverage ratio below 1.0, up 2.7 percentage points from 37.0% in 2019. The interest coverage ratio is the ratio of operating profit to interest expenses; a ratio below 100% means that operating profit earned in a year is less than the interest expenses.

In other words, last year, four out of ten domestic companies experienced severe management difficulties to the extent that they could not even cover their interest expenses. The situation is particularly severe for SMEs. During the same period, the interest coverage ratio for SMEs rose from 47.0% to 50.9%, meaning that more than half cannot even afford their interest payments.

The gap in debt repayment ability between companies has also widened. Last year, the proportion of companies with a debt ratio exceeding 200% (over-indebted companies) was 15.3%, significantly surpassing 12.4% at the end of the previous year. Notably, from 2016 to 2019, the majority of companies with debt ratios over 200% were large corporations, but last year, this reversed with large corporations at 13.6% and SMEs at 17%. This can be interpreted as various financial support policies prepared by the government to resolve the COVID-19 crisis instead transferring into insolvency.

If SME debt becomes massively non-performing, the risk will be borne entirely by financial companies. A stress test conducted by the Bank of Korea, assuming financial imbalances worsen over the next three years and growth falls to around -2.2% annually, showed that corporate credit losses would surge from 8.7 trillion won to 27.5 trillion won. During this period, household credit losses would increase only from 5.4 trillion won to 9.6 trillion won.

Default rates are also estimated to rise by 0.35 percentage points for households, whereas for companies, it is expected to increase from 1.48% to 2.36%, a 0.88 percentage point rise. This means that if the economic situation deteriorates, losses among companies will be greater than those among households, inevitably increasing the risk for financial institutions that have expanded corporate loans.

Professor Kim Sang-bong of Hansung University’s Department of Economics expressed concern, saying, “If the government cuts support measures during the interest rate hike period, insolvency among marginal companies will surface, potentially leading to a chain of bankruptcies.”

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