[Weak Link - Self-Employed] One in Five Personal Business Loans Defaulting... Household Debt Time Bomb

Risk of Defaults After September End of Loan Extension and Interest Payment Deferral
Additional Bank Provisions of 5.4 Trillion Won... Equivalent to 60% of Last Year's Earnings

[Asia Economy Reporter Kiho Sung] One in five individual business owners who have taken out bank loans is at high risk of insolvency. This is due to the prolonged COVID-19 pandemic causing a sharp decline in sales and an increase in debt for interest payments and living expenses, significantly worsening their financial condition. Although indicators appear very stable, the risk of insolvency among small business owners, masked by maturity extensions and interest payment deferrals, is widely expected to intensify after the support measures end in September. Accordingly, an analysis suggests that the additional loan loss provisions banks need to accumulate after the policy support ends in September will reach 5.4 trillion won. This amount corresponds to 62% of the net income earned by banks last year.

According to the report titled “The Risk of Insolvency for Small Business Owners and Self-Employed Hidden by Maturity Extensions and Interest Payment Deferrals and the Distortion Level of Asset Soundness Indicators for Banks and Savings Banks,” published by Korea Ratings on the 29th, the proportion of loans showing signs of insolvency among all individual business owner loans at the end of last year was estimated at 20.4% for banks and 27.3% for savings banks. This means that one out of five bank loans and one out of four savings bank loans are considered insolvent.

Considering that the ratio of loans classified as watchlist or below for individual business owner loans at banks and savings banks was 0.6% and 19.6%, respectively, at the end of last year, the proportion of loans showing signs of insolvency is very high. Taeyoung Ahn, Senior Researcher at Korea Ratings’ Financial Research Division 1, pointed out, “The asset soundness classification indicators are lagging, and since the classification of loans with maturity extensions and interest payment deferrals has been maintained since April last year, these loans are likely still classified as normal because the application conditions for maturity extensions and interest payment deferrals require no principal or interest arrears, no capital erosion, or business closure.”

Analysis Suggests Banks Need Additional Loan Loss Provisions of 5.4 Trillion Won

Accordingly, it is pointed out that banks and savings banks need to proactively accumulate loan loss provisions for loans showing signs of insolvency in preparation for the end of government financial support policies. The report calculated that, as of the end of last year, the additional loan loss provisions required for loans showing signs of insolvency were 5.4 trillion won for banks and 75.3 billion won for savings banks. This corresponds to 61.8% and 16.2% of their net income at the end of last year, respectively.

Furthermore, with market interest rates rising recently, especially long-term rates, and the prolonged COVID-19 pandemic increasing the debt burden on small business owners, the report assumes a conservative scenario where interest rates rise by 1 percentage point and the average debt of small business owners increases by 100 million won. Under this scenario, the additional loan loss provisions required for banks and savings banks would increase to 6 trillion won and 104.8 billion won, respectively. This corresponds to 69.2% and 22.6% of their net income at the end of last year.

Senior Researcher Ahn warned, “If the loan maturity extension and interest payment deferral measures end by the end of September, from the fourth quarter of this year, delinquent loans will be sequentially classified as watchlist or substandard, likely leading to increased loan loss expenses from next year onward.” He added, “If insolvency materializes, the recognition of temporary losses could cause significant ripple effects not only for individual banks and savings banks but for the entire financial industry.”