[Debt-Ridden CEOs]③Can Banks Handle the Risks of Small and Medium Enterprises?

Currently, the Delinquency Rate Has Risen Slightly
Unusual Sales and Bankruptcy Indicators

Allowance for Loan Losses to Cover Risks Is at a Healthy Level
Financial Authorities: "Insufficient Compared to Advanced Countries... Additional Reserves Needed"

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"Currently, the delinquency rate is judged to have just started to rise. The future trend is important. If the delinquency rate surpasses the level expected at the beginning of the year, activating Plan B will be necessary." This is the assessment of a commercial bank president regarding the current delinquency situation among small and medium-sized enterprises (SMEs).

Banks consider sales and corporate bankruptcies as the most important indicators determining the direction of the delinquency rate. Both situations are unfavorable. The Bank of Korea reported that the sales growth rate of SMEs (year-on-year) fell from 14.4% (end of Q4 2021) to 10.4% (end of Q3 2022). The Ministry of SMEs and Startups also released statistics showing that the number of bankrupt corporations nationwide increased by 18 in Q4 last year to 48 compared to the previous quarter.

Current risk management indicators are favorable, but

Still, banks have some support to rely on. The loan loss provision ratio and liquidity ratio are much higher than the regulatory levels set by financial authorities. Loan loss provisions refer to funds that banks set aside in advance as expenses to cover sudden losses such as delinquencies. Banks evaluate the loan loss provision ratio, which is the loan loss provisions divided by non-performing loans overdue for more than three months, as a risk management indicator.

According to the Bank of Korea, the loan loss provision ratio of domestic banks was 231.0% in Q4 last year. This is 46 percentage points higher than 185.5% in Q4 2021. This means that the loss absorption capacity has increased accordingly. Although there is no regulation on how much loan loss provisions must be set aside, financial authorities have issued guidelines instructing banks to maintain a ratio above 200%.

The Liquidity Coverage Ratio (LCR), which shows how much surplus funds banks hold, has also increased. LCR refers to the ratio of highly liquid assets such as deposits and government bonds to the net cash outflows of a bank over 30 days. As of January this year, the LCR was 113.6%, up 17.6 percentage points from 96% a year earlier. The Bank of Korea evaluated that "overall, risk management indicators are maintaining a favorable level."

Delinquency rate may rise further in Q2... insufficient preparation compared to advanced countries

Nevertheless, banks plan to further increase loan loss provisions this year in preparation for the risk, including delinquencies, spreading further. Kim Kwang-soo, chairman of the Korea Federation of Banks, said, "Signs of rising delinquency rates have already appeared in Q1, and from Q2, the delinquency rate will rise much more sharply than now," adding, "Banks need to set aside more provisions in advance."

Financial authorities also judge that although loan loss provisions are high relative to non-performing loans, they are insufficient compared to total loans. Kim Jun-hwan, director of the Bank Supervision Department at the Financial Supervisory Service, said, "The provision ratio relative to total loans has declined during the asset growth process of banks," and "Banks need to continuously expand their loss absorption capacity going forward." As of September last year, the provision ratio relative to total loans of the five major banks was 0.51%. Director Kim emphasized, "In advanced countries, the provision ratio relative to total loans is about 1.6 to 1.7%, higher than in Korea," adding, "There is still a long way to go."

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