Small Business 'Fast Loans' Result in Triple Increase in Default Rate

Korea Credit Guarantee Fund Rapidly Provides Funds to Small Businesses Affected by COVID-19
Issues Emerge Two Years After 'Small Business Entrusted Guarantee'
National Assembly Budget Office: "Default Rate Soars to 9.3%, Measures Needed"

A restaurant owner in downtown Seoul is updating the menu with increased prices. Photo by Asia Economy DB

Although the government increased the guarantee scale and facilitated quick loans for small business owners affected by COVID-19, the default rate has risen. This system, called the 'Small Business Owner Entrusted Guarantee,' was provided by the Korea Credit Guarantee Fund (KODIT) during 2020-2021.

The loan process was simplified, and the guarantee limit was increased. Unlike general guarantees, where KODIT conducts on-site investigations to assess creditworthiness, repayment ability, and financial soundness, the requirements were significantly reduced. The lending banks only checked for tax delinquencies and arrears based on a review checklist. The guarantee ratio was 95%, which is generally higher than the 70-100% guarantee ratio of general guarantees. This means that if a small business owner borrows 10 million KRW from a bank and fails to repay, KODIT must repay 9.5 million KRW on their behalf.

Helped to Get Loans Easily, but the Problem Is More Defaults

The problem is that while 'quick loans' were facilitated considering the difficult circumstances of small business owners, they are more likely to fail to repay principal and interest properly compared to general guaranteed loans. According to the '2022 Fiscal Year Settlement' report recently published by the National Assembly Budget Office, the balance of small business owner entrusted guarantees was 6.1235 trillion KRW as of the first quarter of this year. The default rate was 9.3%. Defaults occur when small business owners who borrowed money delay principal and interest payments or apply for temporary closure, business closure, rehabilitation, or bankruptcy. At the same time, the default rate for general guarantees was 3.2%, about three times lower.

As the default rate rises, KODIT’s subrogation payments?repaying debts to banks on behalf of small business owners according to the guarantee ratio?increase. The subrogation payment ratio, which is the proportion of subrogation payments made by KODIT out of total loans, was 4.9% for small business owner entrusted guarantees as of the first quarter this year. This was also higher compared to the 2.1% subrogation payment ratio for general guarantees.

The National Assembly Budget Office pointed out, "The loan maturity structure for small business owner entrusted guarantees is a 3-year grace period followed by 2 years of installment repayment. From May this year, the burden of principal repayment has become a reality in addition to interest payments," adding, "There is a possibility that default and subrogation payment rates will rise sharply, highlighting the importance of risk management for small business owners."

Small Business Owners’ Sales and Credit Ratings Expected to Worsen

KODIT has been conducting consulting for small business owners with weak credit since last year to manage the risks of entrusted guarantees. The Budget Office advised, "An effect analysis between companies that received consulting and those that did not should be conducted, and the program should be improved accordingly. Considering the time required, the introduction was delayed, but consulting that can reduce guarantee risks must be provided in a timely manner."

Meanwhile, the sales conditions and credit ratings of small business owners are expected to deteriorate further. As policy finance becomes increasingly important as a support pillar for small business owners, the vicious cycle of rising defaults is likely to continue.

According to a survey conducted by the Korea Credit Guarantee Foundation targeting 115 heads of 17 regional credit guarantee foundations nationwide, 41.2% of respondents answered that the 'sales trend of small business owners in the second quarter of this year' had 'worsened.' Only 14.4% said it had 'improved.' Regarding 'sales outlook,' 44% expected it to 'worsen.' The credit risk index for the second quarter was 42.2. Respondents anticipated it would rise to 51, 8.8 points higher. The credit risk index increases as the perceived credit risk of small business owners who borrowed money rises.

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