[Song Seungseop's Financial Light] How Does the 'Loan Cliff' That Seems to Plummet Appear?

Regulatory Restrictions and Interest Rate Cuts Cause Loan Cliff
No Side Effects from Maximum Interest Rate Reduction Despite Various Concerns

[Image source=Yonhap News]

[Asia Economy Reporter Song Seungseop][Asia Economy Reporter Song Seungseop] Looking down a sheer cliff evokes a dizzying and fearful feeling. There is a famous cliff in the financial sector as well. It is called the ‘loan cliff.’ How does the loan cliff form, and why is it dangerous?

The loan cliff refers to a sudden increase in the loan threshold due to interest rates or government regulations. It includes not only failing loan screenings but also paying higher interest rates or having reduced loan limits compared to the past.

The causes are diverse. When authorities tighten regulations to make loan screenings stricter, private banks have no choice but to reduce loan limits. When total loan volume regulations such as the Debt Service Ratio (DSR) are implemented, borrowers face a situation where their loan limits relative to income decrease.

Policies that lower the legally set maximum interest rate also increase the possibility of a loan cliff. When loan interest rates decrease, private banks, concerned about deteriorating profitability, conduct more stringent loan screenings. They are less likely to lend money to people who seem unlikely to repay. Banks also incur costs during the loan process, and if the maximum interest rate is too low, loan operations will shrink.

The loan cliff is dangerous because most victims are low-income and low-credit individuals. When loan screenings become stricter for various reasons, those with low credit ratings and struggling livelihoods are judged to have lower ‘repayment ability,’ making it harder for them to borrow money. Some people excluded from the formal financial system may turn to illegal loan sharks charging extremely high interest rates due to urgent circumstances.

Concerns about the Loan Cliff Were High, but the Financial Services Commission Says "No Side Effects from Maximum Interest Rate"

Concerns about the loan cliff intensified last year when the government and financial authorities announced a reduction in the legal maximum interest rate. The Financial Services Commission estimated that when the legal maximum interest rate was lowered from 24% to 20% on July 7, the number of financial users would decrease by 316,000. They also predicted that 39,000 people would fall into illegal private financing. Academia warned that the side effects could be greater, with hundreds of thousands facing the loan cliff.

There was a similar case. The Korea Inclusive Finance Agency analyzed the impact of lowering the maximum interest rate from 27.9% to 24%, finding a sharp decline in the number of new loan applications and approved customers at loan companies. Among the loan companies surveyed, those that stopped all unsecured loans increased by 9.7 percentage points to 16.3%.

Japan also had a similar precedent when it rapidly lowered the maximum interest rate from 29.2% to 20% in 2010. According to the ‘Market Changes Over 10 Years After Strengthening Loan Business Regulations in Japan’ report by the Credit Finance Research Institute, the number of registered loan companies in March last year was 1,647, a 73.3% decrease compared to March 2009. The Japan Financial Services Agency found that the number of illegal loan users increased more than sevenfold since 2010.

However, despite various concerns, a loan cliff due to the maximum interest rate reduction has not yet appeared. On the 16th, the financial authorities held the 2nd meeting of the ‘Maximum Interest Rate Reduction Implementation Task Force’ to check trends in the unsecured loan market for low-credit borrowers affected by the rate cut. They reported that there was no significant decrease in unsecured loan volumes before and after the reduction in the financial sector.

Meanwhile, following the implementation of the legal maximum interest rate reduction, the ‘Sunshine Loan 15,’ which lowered the interest rate of ‘Sunshine Loan 17’ by 2 percentage points, has also been launched. Sunshine Loan is a policy loan product targeting the lowest credit borrowers with an annual income of 35 million KRW or less, or 45 million KRW or less with a personal credit score in the bottom 20%. Since its launch on the 7th, 6,159 loans have been supplied by the 15th, amounting to 40.46 billion KRW.

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