What Is a Bad Bank? A Financial Support Plan Emerging for Small Business Owners and Self-Employed Affected by COVID-19

"Refined Policy Setting Needed to Dispel Concerns of Moral Hazard"

[Asia Economy Reporter Yu Je-hoon] The Presidential Transition Committee is seriously considering the idea of a ‘Bad Bank’ as a solution to the debt problems faced by small business owners and self-employed individuals pushed to their limits by COVID-19. Financial circles unanimously agree that precise policy design is necessary to dispel concerns about ‘moral hazard’ that arise whenever a bad bank is introduced.

According to political and financial sources on the 1st, Ahn Cheol-soo, chairman of the Presidential Transition Committee, stated in an economic division briefing the previous day, "Please actively review in the relevant division the creation of a kind of bad bank jointly funded by the Small Enterprise and Market Service, the government, and banks, which would allow long-term, low-interest repayment of overdue loans comparable to mortgage loans."

Voices calling for the introduction of a bad bank are also growing outside the transition committee. The Korea Institute of Startup & Entrepreneurship Development, in a report released the previous day, cited the establishment of a small business owner-exclusive ‘Stepping Stone Fund (Bad Bank)’ as a measure to reduce debt and restructure liabilities to solve the debt problem of small business owners. On the 30th, Lee Jae-hak, an advisor at Shinhan Bank, proposed the establishment of a ‘Small Business Loan Management Organization (tentative name)’ with the characteristics of a bad bank at a forum hosted by Yoon Chang-hyun, a member of the People Power Party.

A bad bank is an institution that purchases and separately manages non-performing assets or bonds. For banks and other financial institutions, instead of blindly accumulating reserves, they can strengthen soundness by receiving sales proceeds and removing non-performing loans from their books. Small business owners and self-employed individuals pushed to their limits can also benefit from debt relief and adjustment programs, enabling debt repayment accordingly. Such bad banks have been introduced during every economic crisis phase. During the Asian financial crisis, the Non-Performing Asset Resolution Fund was established; during the credit card crisis, Hanmaeum Finance; and during the global financial crisis, the Credit Recovery Fund was set up.

The reason the bad bank introduction theory is gaining momentum is that the situation of small business owners and self-employed individuals has rapidly deteriorated due to the impact of COVID-19. According to the Bank of Korea, as of the third quarter of last year, the loan size for self-employed individuals was 887.5 trillion won, an increase of about 14.2% compared to the same period the previous year. This increase is larger than that of household loans. Although the non-performing loan ratio (overdue interest for more than three months) of domestic commercial banks is managed at a low level of 0.50%, the financial sector evaluates this as a ‘visual illusion effect’ due to COVID-19 financial support.

According to the Financial Services Commission, as of the end of January, the loan size benefiting from maturity extension and repayment deferral in the financial sector reached a total of 133.4 trillion won based on outstanding balance: ▲maturity extension 116.6 trillion won ▲principal repayment deferral 11.7 trillion won ▲interest repayment deferral 5 trillion won. Although not all of these loans will become non-performing, there are considerable concerns that accumulated non-performing loans may burst all at once when the maturity extension and repayment deferral end at the end of September.

However, the financial sector also expresses concerns that the introduction of a bad bank could lead to moral hazard among some borrowers. A financial sector official said, "Even during the COVID-19 financial support phase, there were borrowers who received maturity extension and repayment deferral benefits despite having sufficient repayment ability," adding, "Even if a bad bank is established to provide support, a precise screening process to filter out borrowers with sufficient repayment ability needs to be conducted."

Professor Kim Sang-bong of the Department of Economics at Hansung University said, "Unlike before, the unit size of non-performing loans that need to be handled by the bad bank has increased due to economic growth," and added, "Detailed policy design is necessary, such as expanding the unit (amount) of non-performing loans handled."

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