Corona-induced Debt Festival... Potential Financial Vulnerability at 'Caution' Stage

Bank of Korea 'Financial Stability Situation' Report

[Asia Economy Reporter Kim Eunbyeol] The prolonged COVID-19 pandemic has increased the latent vulnerabilities of South Korea's financial system to levels comparable to the 2008 financial crisis. It is also projected that by the end of this year, one in five domestic companies will fall into the category of "zombie firms." The ratio of household debt to disposable income has also reached an all-time high.

On the 24th, the Bank of Korea announced in its "Financial Stability Report" that the new Financial Stability Index (FSI-Q) rose to 70.1 in the second quarter of this year. This is the highest level since the third quarter of 2008 (72.3). At the end of last year, the FSI-Q was around 64.1, rising to 68.2 in the first quarter of this year, and surpassing 70 in the second quarter. The FSI-Q, newly developed by the Bank of Korea this year, considers a value above 66 as the "caution" stage and above 81 as the "crisis" stage. A Bank of Korea official explained, "The vulnerability has continuously increased due to a strong risk appetite amid a sharp rise in loans. The main factors are the heightened risk appetite in the real estate market and the increase in debt in both the household and corporate sectors."

Reflecting financial conditions in the second quarter, the Bank of Korea's forecast for the Growth-at-Risk (GaR) over the next year is -4.5% (annualized), a decline of more than 1 percentage point compared to -3.0% a year ago. GaR refers to the growth rate at the 5th percentile of possible future Gross Domestic Product (GDP) growth rates under current financial conditions.

The Bank of Korea estimated that the proportion of zombie firms?companies unable to cover interest expenses with operating profits?will rise to 21.4% this year. This means that one in five companies will become zombie firms, totaling 5,033 companies.

At the end of last year, the proportion of zombie firms was 14.8%, indicating an increase of 6.6 percentage points in just one year. The debt owed by zombie firms is expected to reach 175.6 trillion won this year, an increase of 60.1 trillion won compared to the end of last year.