The Bank of Korea: "If Household Debt Continues to Rise, It Will Negatively Affect Growth... Loan Demand Must Be Reduced"

Lee Chang-yong, Governor of the Bank of Korea, is striking the gavel at the Monetary Policy Committee plenary meeting held at the Bank of Korea in Jung-gu, Seoul on the 13th.
[Photo by Yonhap News]

The Bank of Korea pointed out that if household debt in South Korea continues to increase sharply at the current pace, it could have a negative impact on long-term growth trends. It explained that policies to reduce loan demand are necessary, such as applying differentiated Loan-to-Value (LTV) ratios by level and reducing exceptions to the Debt Service Ratio (DSR).

On the 17th, the Bank of Korea analyzed in its 'BOK Issue Note' titled "Causes and Effects of Household Debt Increase from an Institutional Perspective and Soft Landing Measures" that while the household debt-to-GDP ratio in major countries has gradually declined since the global financial crisis, South Korea's ratio has continuously risen.

According to the Bank of Korea, South Korea's household debt-to-GDP ratio, which ranked 14th among 43 major countries in 2010, stood at 105.0% as of the fourth quarter of last year, the third highest after Switzerland (128.3%) and Australia (111.8%).

The reasons for the accumulation of household debt include the high profitability and stability of household loans compared to corporate loans, insufficient borrower-level loan regulations, and increased asset demand due to prolonged low interest rates.

From the loan supply perspective, since household loans are more profitable and subject to less capital regulation burden than corporate loans, banks had no choice but to actively provide household loans.

Additionally, South Korea introduced the DSR relatively late in the second half of 2018 compared to major countries, has many exceptions, and financial institutions' lending practices for unsecured loans are relatively lenient.

In particular, the expansion of jeonse loans has significantly increased household debt, and the prolonged low interest rate environment has greatly reduced households' borrowing costs and the real returns on safe assets, providing strong incentives for households to borrow and invest in other assets such as stocks.

The Bank of Korea explained that while the current high level of household debt is unlikely to lead to financial instability, negative external effects such as constraints on the long-term growth of the economy and widening asset inequality are inevitable.

Therefore, the Bank of Korea emphasized the need to gradually achieve deleveraging in the household sector through a combination of macroprudential and monetary policies. It explained that a comprehensive policy framework is necessary.

First, the Bank of Korea pointed out that loan demand should be reduced by narrowing exceptions to the DSR, applying differentiated interest rates by LTV level, and imposing additional interest rates on lump-sum repayment methods.

The differentiated application of LTV means applying lower interest rates when the LTV is low and higher interest rates when the LTV is high. This has the effect of encouraging borrowers not to take out excessive loans.

In addition, the Bank of Korea explained the need to consider introducing a "prudential monetary policy." The Monetary Policy Board operates monetary policy for price stability and financial stability, but if problems such as household debt worsen, it may be necessary to place greater emphasis on financial stability in conducting monetary policy.

The Bank of Korea stated, "It is necessary to actively consider financial stability to prevent accommodative monetary policy from leading to excessive leverage and risky asset investment by economic agents, and to pay attention to communication so that households do not underestimate the risks of future interest rate fluctuations."

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