Half of SMEs Unable to Repay Interest... 'Reluctant' Grace Period Measures Only Provide Temporary Relief

Due to the rapid increase in COVID-19 cases, social distancing measures in the Seoul metropolitan area are being extended. On the 4th, the Myeongdong area in Jung-gu, Seoul, remained quiet even on the holiday. Photo by Jinhyung Kang aymsdream@

SME Loan Balance at the End of July Reaches 858 Trillion Won

Increased by Nearly 10 Trillion Won in Just One Month

[Asia Economy Reporters Eunbyeol Kim, Hyojin Kim] # Self-employed business owner Mr. A, who runs a restaurant in Daegu, has been losing sleep lately due to loan repayments. Since early last year, the COVID-19 pandemic caused a sharp decline in sales, making it difficult to even cover monthly rent. He took out a 60 million won loan using COVID-19 financial support. Although the loan was fully used for rent and employee wages, the situation did not improve, so he utilized a commercial bank’s ‘Small Business Financial Support’ program to defer principal repayments for about six months. He lamented, "Thanks to the financial support, I have been paying only interest instead of principal for six months, but from the end of the year, I have to start repaying the principal as well, and the future looks bleak." He sighed, adding, "Even if the COVID-19 situation calms down, I am worried because interest rates are expected to rise soon."

As expectations grow that the Bank of Korea will raise the base interest rate by the end of this month, small and medium-sized enterprises (SMEs) and self-employed individuals are becoming increasingly anxious. While the economy is recovering due to strong exports and debt is surging, the possibility of interest rate hikes is rising. Vulnerable companies that took out loans with variable interest rates are bound to be hit hard. Although financial institutions are barely helping by deferring principal and interest repayments following government recommendations, debts continue to increase. Meanwhile, the number of companies weakened to the point where they cannot even cover interest with operating profits is also rising.

More Than Half of SMEs Cannot Cover Interest Expenses with Operating Profit

According to the Bank of Korea on the 12th, more than half of SMEs are vulnerable companies that cannot properly repay even the interest on their loans. Among 1,244 SMEs that disclosed business reports last year, 50.9% had an interest coverage ratio (operating profit/total interest expenses) below 1. An interest coverage ratio below 1 means the company cannot pay interest from operating profits. This means more than one in two SMEs are on the brink of financial and managerial collapse. This figure has increased by more than 11 percentage points from 39.6% in 2015 over five years. Compared to large corporations (28.8%), SMEs are generally much weaker in their ability to pay interest.

The increasing dependence of SMEs on loans is also a problem. According to the Bank of Korea, as of the end of last month, the outstanding bank loans to SMEs reached 858.1 trillion won, increasing by 9.1 trillion won in just one month. Bank loans to SMEs have increased by nearly 54 trillion won from January to July this year alone. As of last month, the share of SME loans among the five major commercial banks?KB Kookmin, Shinhan, Hana, Woori, and NH Nonghyup?reached 40.3%, surpassing 40% for the first time in over a decade since the global financial crisis. For SMEs to regain financial capacity, they must overcome management difficulties, but the outlook remains bleak. Last year, the sales growth rate of SMEs was 0.8%, half of the 1.5% recorded in 2019 before COVID-19.

In this situation, if interest rates rise, the financial burden on marginal SMEs and self-employed individuals still affected by COVID-19 will inevitably increase rapidly. Signs of rising corporate loan interest rates are already appearing. According to the Korea Financial Investment Association, the AAA-rated financial bond interest rate was 1.086% on January 4 this year, rose to the 1.3% range in June when the Bank of Korea began signaling a base rate hike, and reached 1.581% on August 11. The benchmark interest rate used to determine loan rates is already reflecting the base rate hike and rising.

"Reluctant Financial Support Only Increases Marginal Companies" Criticism Arises

Vulnerable companies are barely holding on thanks to government and Bank of Korea financial support for COVID-19 affected businesses. The government is reportedly leaning toward extending the loan maturity extension and interest repayment deferral measures for small business owners and SMEs, which are set to expire at the end of next month, by another six months.

However, continuously postponing financial burdens does not solve the fundamental problem. In its Financial Stability Report released in June, the Bank of Korea stated, "To strengthen companies’ ability to pay interest and reduce the number of vulnerable companies, improving sales and operating profits through domestic and international demand recovery and enhancing corporate competitiveness is a more fundamental and urgent task than reducing interest expenses through financial support." It explained that if chronically insolvent companies merely survive without restructuring, it could hinder the efficient allocation of resources. The Bank of Korea advised, "To implement corporate support policies efficiently, a system should be established to more precisely assess companies’ debt repayment ability and recovery potential."

A corporate loan officer at a commercial bank also expressed concern, saying, "Once the deferral period ends, companies will have to repay principal and interest spread over the remaining loan period. Unless the government or the Bank of Korea fully subsidizes the interest, the financial burden on corporate clients may actually increase after the deferral ends."

Accordingly, there are calls to encourage companies to repay at least some of their debts rather than simply extending SME and self-employed loans. Professor Donghyun Ahn of Seoul National University’s Department of Economics said, "Since most corporate loans from banks are given at variable interest rates, the structure is vulnerable to interest rate hikes. The Financial Services Commission should play a role in helping banks diversify their corporate loan products." He suggested that even if loans were initially taken out at variable rates, there could be options to convert to fixed rates once interest rates rise beyond a certain point, with banks charging additional margins.

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