[In-Depth Review] Household Debt Measures Require Specific Management Indicators

On the 13th of last month, the Financial Services Commission announced measures to manage household loans. Due to concerns that excessive household debt could pose a risk to the economy, the plan is to maintain credit supply to low-income earners and small business owners while strengthening repayment ability assessments through DSR (Debt Service Ratio) to control the total amount of unsecured loans. Authorities including the Financial Services Commission, the Ministry of Economy and Finance, and the Bank of Korea have officially acknowledged for the past 7 to 8 years that if household debt is not properly managed, it could become a serious threat to the economy.

Nevertheless, no improvements can be found in the indicators shown every time a new measure is announced. Even in this announcement, household debt relative to disposable income increased by 32.6 percentage points from 158% in 2014 to 190.6% in 2019, and household debt relative to Gross Domestic Product (GDP) rose by 15 percentage points from 82.9% in 2014 to 97.9%. These figures have never decreased.

The World Economic Forum has suggested critical thresholds for household debt: debt balance relative to GDP at 75%, and principal and interest repayment relative to disposable income at 20%. Claudio Borio, former director of the Bank for International Settlements and a global expert in this field, considered household debt exceeding 85% of GDP as surpassing the critical threshold. As of 2019, the average household debt relative to disposable income among OECD countries was 144.2%, and household debt relative to GDP was 65.6%. Meanwhile, during the subprime mortgage crisis and global financial crisis in 2007-2008, U.S. household debt was 96-98% of GDP, and during the sharp declines in stock and real estate prices in Japan from 1989 to 1991, household debt was 56-60% of GDP. Compared to these indicators, it is clear that South Korea’s household debt is excessive and serious. However, the measures proposed by the Financial Services Commission do not show specific indicators to manage this issue.

The only point the Financial Services Commission cites as a policy effect is that the annual growth rate of household debt, which was 8% to 11%, has decreased to about 4% to 5% over the past three years. However, it is said to have expanded again this year. Moreover, the growth rate of disposable income also slowed during the same period, so the ratio of household debt to disposable income has continued to increase, making it difficult to view this as a positive outcome.

Above all, the current scale of household debt largely stems from past policies encouraging borrowing to buy homes and continuous expansion of credit supply, so the indicators cited by the Financial Services Commission appear too complacent. For several years, the Commission has explained that as the economy grows, it is natural for household debt to expand quantitatively, and that reducing debt size is unnatural. If this is natural, then the Commission should also clarify at what level of household debt in a given economy the risk becomes significant and disclose management indicators, but there is no mention of this. They initially stated they would manage the household debt to disposable income ratio below 165%, but after exceeding that threshold, they quietly removed the indicator and no longer use it as a standard. It is unclear what specific level the Financial Services Commission intends to manage household debt at.

The Financial Services Commission itself says that to maintain stable growth and manage risks, it is necessary to continue managing the pace of household debt increase and ensure a soft landing. If so, the Commission should have a concrete stance, based on detailed analysis and review of overseas cases, to manage household debt size using the aforementioned critical thresholds or OECD averages as management indicators. Above all, since more than 50% of household loans are mortgage loans, a delicate plan to reduce total debt should be established, starting with reducing mortgage loans for multi-homeowners. Failing to do so is akin to watching a time bomb like the subprime mortgage crisis explode. The Financial Services Commission must now present and implement specific plans and indicators to reduce the total amount of household debt to the public.

Baek Juseon, Attorney at Law, Law Firm Yungpyeong