Raising the Legal Maximum Interest Rate According to Market Rates Could Save 1.02 Million Vulnerable Borrowers

Base interest rate rise causes 2nd-tier financial institutions' funding rates to increase by 3.5%p since last year-end
Vulnerable borrowers pushed to private loan market due to 20% legal maximum interest rate
If linked legal maximum interest rate adopted, 1.02 million borrowers could access loan market

"My credit score is 689, and I am unemployed. In the past, I kept borrowing only through card loans, but when I inquired about card loans again this time, I was told that since last year the legal maximum interest rate has been lowered, so I couldn't get a loan. A loan company introduced by an acquaintance quoted interest rates over 40%, and I am worried about whether I should borrow money. Some people at the loan company even scare me by saying I shouldn't take out a loan if possible... What should I do?" (Posted on the loan information sharing portal community on the 7th)

Amid concerns that the fixed legal maximum interest rate of 20% during a period of rising interest rates is actually choking low-credit borrowers, a study has found that switching to a market-linked legal maximum interest rate system, which changes according to market interest rates, would have a positive impact on financially vulnerable consumers. The report titled "The Necessity of Introducing a Market-Linked Legal Maximum Interest Rate," published by the Korea Federation of Credit Finance Associations on the 6th, contains these findings. The market-linked legal maximum interest rate system is a scheme where the legal maximum interest rate fluctuates according to market interest rates.

The report reflected the current situation where the funding cost for secondary financial institutions (the interest rate at which financial companies procure funds for household loans) rose by 3.5 percentage points from the end of last year to November this year (3-year AA+ card bonds rose from 2.37% to 5.87%) and investigated what results would occur if the market-linked legal maximum interest rate also rose from 20% to 23.5%. Under the fixed legal maximum interest rate, about 1.06 million borrowers, accounting for 96.9% or 1.02 million of those excluded from the market, would be able to participate in the loan market under the market-linked legal maximum interest rate system.

Increased Consumer Utility When Switching to Market-Linked Legal Maximum Interest Rate

Changing to a market-linked legal maximum interest rate system also increases consumer utility. When the funding cost rises by 3.5 percentage points, under the fixed legal maximum interest rate, consumer surplus decreases by about 67,000 to 84,000 KRW per borrower per month, whereas under the market-linked legal maximum interest rate, it decreases by only 4,000 to 5,000 KRW. The consumer surplus resulting from the policy change is calculated as the difference between these two figures, resulting in an increase of about 63,000 to 79,000 KRW per borrower per month.

Kim Miru, a research fellow at the Korea Development Institute (KDI) and author of the report, analyzed, "With the base interest rate hikes, the funding costs for credit finance companies rise even faster. When funding costs rise, households that were subject to interest rates close to the legal maximum interest rate are excluded even from card companies and capital companies, which can significantly reduce the welfare of vulnerable groups."

Need for Relief Measures for Vulnerable Households Borrowing at Legal Maximum Interest Rates During Rising Interest Rate Periods

The report also emphasized that households borrowing at the legal maximum interest rate are mainly vulnerable households (those in the bottom 20% of credit scores or in the second income quintile or below according to the National Tax Service) and multiple debtors (those who have borrowed from three or more financial institutions). According to data from domestic credit rating agencies as of June, only 8.9% of households using low-interest credit loans at 4% were vulnerable households, whereas 84.8% of households using high-interest credit loans close to the legal maximum interest rate (18-20%) were vulnerable households.

Additionally, about 10.8% of households using low-interest loans below 4% were multiple debtors, while 48.6% of households using high-interest loans close to the legal maximum interest rate were multiple debtors.

The report concluded, "Introducing a market-linked legal maximum interest rate system that adjusts the legal maximum interest rate in line with the rise in funding costs can significantly alleviate the exclusion of vulnerable borrowers due to rising funding costs. It is necessary to consider using the interest rates of Monetary Stabilization Bonds (1-year) or Treasury Bonds (2-year), which have maturities similar to general credit loans, as benchmark rates for the market-linked legal maximum interest rate in Korea."

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