Bank Loan Loss Provision Ratio Hits Record Low... Authorities Urge "Increase Provisions"

[Asia Economy Reporter Song Hwajeong] Domestic banks have been found to have the lowest loan loss provision ratios among major banks. In response, financial authorities are actively encouraging banks to accumulate sufficient provisions.

According to Kiwoom Securities on the 6th, the average loan loss cost ratio for the first quarter of this year among the four major banks?KB Kookmin, Shinhan, Hana, and Woori?remained at 0.08% of total loan receivables, continuing from last year. As a result, the ratio of loan loss provision balance to total loan receivables in the first quarter was 0.44%, down 0.04 percentage points compared to the end of 2020. Seo Youngsoo, a researcher at Kiwoom Securities, pointed out, "This level is significantly low compared to past averages or cases of overseas banks," adding, "If the asset market downturn triggered by interest rate hikes prolongs, loan loss costs could surge sharply, increasing financial stability risks."

The current provision evaluation criteria, which are based mainly on past default rates and loss rates, do not properly reflect future losses, leading to the problem of under-provisioning. Currently, the evaluation standard for appropriate provision levels is judged by the provision ratio against non-performing loans, where the non-performing loan ratio is an important indicator derived from past average default and loss rates for calculating provisions. Researcher Seo explained, "For past default rates and loss rates to serve as standards in the provision accumulation process, bank loans should mainly be fixed-rate and principal-and-interest installment loans, but in Korea, variable-rate and interest-only loans are predominant." He analyzed, "The default rates and loss rates of variable-rate, interest-only loans are more influenced by changes in external conditions such as future loan interest rates, household income growth rates, and asset markets than by past experience. Therefore, if provisions are accumulated based on past experience figures, there is a high possibility of under-provisioning."

Financial authorities are actively encouraging banks to accumulate sufficient provisions. Recently, at a meeting with bank CEOs, Jeong Eunbo, Governor of the Financial Supervisory Service, emphasized, "It is necessary to strengthen loss absorption capacity so that banks can perform their fund intermediation functions without disruption despite internal and external shocks," and added, "We should not be complacent with normal standards but conservatively evaluate potential credit risks and accumulate sufficient loan loss provisions."

Additionally, last month, the Financial Supervisory Service formed a task force (TF) with commercial banks to improve the method of reflecting future loan loss provisions and to establish provision accumulation standards. Researcher Seo said, "The reason financial authorities set up the TF to accumulate additional provisions is to reasonably reflect the increased risk rates due to changes in external environments," and added, "For this reason, expanding provision accumulation through changes in irrational standards seems inevitable."

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