Concerns Over Deteriorating Household Loan Soundness... Red Flags for Card, Capital, and Savings Bank Performance

Korea Credit Rating Agency Report: "Household Debt, Concerns Over Hidden Delinquencies Despite Sound Soundness Indicators"

[Image source=Yonhap News]

[Asia Economy Reporter Yu Je-hoon] Warning signs have been triggered for the performance of credit card companies, capital companies, and mutual savings banks as the soundness of domestic household debt, which had been maintained at a good level, shows signs of deterioration.

According to the financial sector on the 23rd, Korea Ratings recently published a report titled "Household Debt, Concerns Over Hidden Insolvency Behind Soundness Indicators," stating, "In sectors with high concerns over the deterioration of household loan soundness, such as credit cards, capital, and savings banks, profit and loss impacts due to bad debt burdens are expected."

According to the report, the ratio of non-performing loans (overdue for more than 3 months) among financial institutions with credit ratings by Korea Ratings stood at 0.43% as of the first half of the year, up 0.1 percentage points from the end of the previous year. The balance of non-performing loans also increased by 2.6% to about 3.7 trillion KRW.

By sector, the balances increased by 63.1 billion KRW in banks, 54 billion KRW in capital companies, and 26.4 billion KRW in savings banks, while credit card companies saw a decrease of about 48.5 billion KRW. In the case of credit card companies, the demand for long-term card loans (card loans) declined due to the Debt Service Ratio (DSR) regulations, and competition among sectors intensified, leading to a downward adjustment of loan interest rates despite the interest rate hikes, which is interpreted as having affected asset soundness.

Korea Ratings stated, "The deterioration of household loan asset soundness appeared limited to certain sectors, and considering that the increase in the non-performing loan ratio is not significant, it is premature to say that the risk of household debt insolvency has fully surfaced at this point." However, it added, "Given the recent changes in the interest rate environment over the past year and the outlook for the economy and interest rates, it is judged that the soundness indicators of household loans, which had been steadily maintained for a long time, have reached a turning point."

The main cause of this increase in insolvency is attributed to the rapid rise in interest rates. The Bank of Korea's base rate, which was around 0.5% in July last year, has increased fivefold to 2.5% in one year. Accordingly, the interest rate on new household loans by commercial banks in the second quarter approached 4.1%, up 1.2 percentage points from the previous year. This pace of interest rate increase is the second fastest in history, following the 4.3 percentage point rise during the 1998 foreign exchange crisis.

From the perspective of the 'interest rate increase rate,' which indicates the growth rate of household interest burden, recent increases are even greater than during the foreign exchange crisis. According to Korea Ratings, the interest rate increase rate was 42% as of the second quarter of this year, higher than the 35% recorded in the second quarter of 1998 during the foreign exchange crisis.

Under these circumstances, sectors with high concerns over household loan insolvency in the event of future economic downturns were identified as credit card companies, capital companies, and savings banks. Although banks and insurance companies account for 52% and 7% of total household loans respectively, they have a high proportion of high-quality borrowers and more than half of their loans are risk-free insurance policy loans, so concerns over soundness are relatively low.

Korea Ratings conducted a stress test under conditions including a 3.0 percentage point increase in loan interest rates, a decrease in public transfer income to 2019 levels, a 30% decline in financial asset prices (fund holdings), and an inflation rate of 6.5%. The results showed that the ratio of watch-list non-performing loans (1-3 months overdue) is expected to increase by 3.8 percentage points to 10.3% for savings banks, by 2.2 percentage points to 7.8% for capital companies, and by 2.1 percentage points to 7.3% for credit card companies compared to the end of the second quarter. Corresponding net income declines are estimated at 423.2 billion KRW (-16%) for credit card companies, 213.8 billion KRW (-11%) for savings banks, and 90.6 billion KRW (-3%) for capital companies.

In particular, considering that capital companies and savings banks have much lower loan loss provision rates for household loans?10% for watch-list non-performing loans and 20% for non-performing loans?compared to credit card companies (50% for watch-list and 65% for non-performing loans), Korea Ratings analyzed that the burden of bad debts could increase sharply as household loan insolvency materializes. Korea Ratings noted, "Given the unprecedented rapid pace of interest rate hikes and the expectation that deferred insolvencies may be latent due to direct and indirect support from financial authorities, the speed of increase in bad loans is expected to be faster than in the past."

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