[Public Voices] Beware of the Transmission of Real Estate-Driven Credit Risk

Interview_Jungho Jeong, Head of Hana Financial Research Institute at Hana Bank./Photo by Hyunmin Kim kimhyun81@

On the 24th, the Bank of Korea's Monetary Policy Committee, which held its last meeting of the year, unanimously adopted a baby step of raising the base interest rate by 0.25 percentage points. At the same time, it presented next year's economic growth forecast for South Korea at 1.7%, below the potential level.

With a less optimistic outlook for the real sector, the U.S. Federal Reserve's (Fed) rate hikes are not yet over, and volatility in the foreign exchange market could intensify at any time, making it difficult to completely alleviate concerns about the widening interest rate differential between domestic and foreign rates and the resulting risk of capital outflows. However, we need to pay closer attention to instability in the domestic short-term funding market and credit market under the current circumstances.

In the market, following the Legoland incident, concerns about the expansion of refinancing risks for PF (Project Financing)-ABCP (Asset-Backed Commercial Paper) and the realization of credit events rapidly spread, greatly amplifying caution regarding credit risk across the short-term funding market and credit bond market. Gangwon Province promised full debt repayment through budget allocation, and since the end of October, the Financial Services Commission and the Bank of Korea have announced comprehensive market stabilization measures (support of 50 trillion KRW + α) focusing on easing funding market instability. However, financial market turmoil caused by Heungkuk Life Insurance’s non-exercise of the call option on new capital securities, concerns about PF defaults due to the possibility of a prolonged real estate market downturn, and other factors continue to sustain a credit avoidance trend. The credit spread (AA-, 3-year corporate bonds minus 3-year government bonds) has exceeded 170 basis points (1 bp = 0.01 percentage points), and the CP (Commercial Paper) to Monetary Stabilization Bond spread (A1, 91-day maturity) has surpassed 200 basis points. These are the highest levels since the 2008 global financial crisis. Moreover, with 30% of life and non-life insurers’ retirement pension assets maturing at year-end, concerns about money outflows due to demand for high-interest deposits have raised the possibility of a money move of up to 30 trillion KRW, leading to worries about large-scale bond sales and liquidity issues originating from insurers.

What is even more concerning is the transmission and spread of funding market instability to the credit market. For example, if the real estate market slump prolongs due to high interest rates, the negative asset effect could further weaken economic momentum and increase the possibility of real estate-related financial instability. As real estate prices continue to decline and funding costs rise, delays or cancellations of real estate PF projects may increase, and the risk of PF loan defaults could grow due to rising unsold inventory. Unlike past cases, the proportion of PF loans has expanded mainly in the non-bank sector, which has less shock-absorbing capacity such as provisions and capital buffers than banks, so in the event of a crisis, not only the actual loss size but also the ripple effects are likely to be greater. To prevent the spread and transmission of risks in specific sectors like real estate from leading to systemic risk, it is necessary to prepare targeted restructuring programs beyond market liquidity support and respond promptly.

Currently, interest rate hikes are being implemented globally as a policy response to prevent the entrenchment of high inflation, but once interest rates rise or tightening policies are fully underway, funding shortages in the bond market are inevitable. Careful responses are needed to ensure that this process becomes an ‘orderly financial tightening’ that minimizes side effects such as market shock propagation or bankruptcies despite surpluses. To this end, the government must take the lead in responding swiftly and actively to prevent liquidity or funding market turmoil from spreading to the credit market.

Jung Joong-ho, Head of Hana Financial Research Institute

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