[Interest Rate Hike Variable] One Word from Yellen... Kookmin Bank Interest Rate Hike Pros and Cons Balanced

1700 Trillion Won Household Debt May Hinder Early Interest Rate Hikes
Raising Rates Needed to Control Household Debt VS Interest Burden May Delay Economic Recovery

Base Rate Hike → Household Loan Interest Burden May Not Have Significant Ripple Effect

Base Rate Should Be Raised Now to Reduce Credit Risk

Household Loan Demand Influenced by Housing Supply and Demand... Not Solely Due to Low Interest Rates

Concerns Over Interest Rate Hikes Premature; Raising Rates Could Slow Economic Recovery

[Asia Economy Reporter Kim Eun-byeol] Should the base interest rate be raised now to curb the rapid increase in household debt, which has grown to a scale comparable to the country's gross domestic product (GDP)? Or would raising rates only increase the interest burden on the 1,700 trillion won worth of household debt, becoming an obstacle to economic recovery?

Following U.S. Treasury Secretary Janet Yellen's remarks on the base interest rate, the possibility of an early rate hike has emerged in Korea as well. However, the historically unprecedented surge in household debt is expected to complicate future decisions on raising rates. Considering the growing household debt and the craze for 'debt investment (debt-financed investment)', opinions are divided between those advocating for an immediate rate hike to reduce credit risk and those urging to maintain the low interest rate stance for the time being as the economy has just begun to recover from the impact of COVID-19. Such concerns were also reflected in the minutes of the 7th Monetary Policy Committee meeting (April 15, 2021) released by the Bank of Korea on April 4.

Time to Consider Normalizing Monetary Policy... Raising Rates May Not Cause Significant Shock to Household Debt?

Recently, commercial banks have collectively raised their spread rates (additional loan interest rates based on creditworthiness and other conditions) in line with the government's tightening loan policies. According to the Bank of Korea, the weighted average interest rate on new household loans from deposit banks was 2.88% in March, up 0.07 percentage points from 2.81% in February. Although the base rate was maintained at 0.50% per annum, loan interest rates have already increased. Interestingly, household loans continued to grow despite the rise in loan interest rates. The outstanding household loan balance at the five major banks?KB Kookmin, Shinhan, Hana, NH Nonghyup, and Woori?stood at 690.8622 trillion won at the end of last month, about 9 trillion won higher than the 681.6357 trillion won at the end of March. This is why there are calls to raise the base rate now to reduce credit risk.

According to the Bank of Korea's Monetary Policy Committee minutes, one committee member stated, "We need to pay attention to the accumulation of potential factors that undermine future financial stability due to the continuation of accommodative monetary policy," and added, "If the economic recovery becomes more evident, it will be necessary to consider operating monetary policy with a greater emphasis on financial stability than at present."

There was also an argument that raising the base rate would not significantly burden existing household loans. One member noted, "Household loan interest rates have risen to levels similar to those before COVID-19," and added, "Even if the Bank of Korea raises the base rate, banks may adjust their spread rates depending on the situation, so the effect on household loan interest rates may not be substantial." Since the impact on citizens' interest burden depends largely on how much spread banks add, raising the base rate may not cause a significant shock. Historically, when benchmark loan rates rose, banks tended to adjust spread rates to ease the burden on borrowers.

Discussion on Rate Hikes Still Premature... Housing Supply and Demand, Not Low Rates, Drive Household Loan Demand

On the other hand, considering uncertainties around vaccines and the impact on face-to-face service sectors hit by COVID-19, some argue that it is still too early to discuss normalizing monetary policy. While household debt has indeed increased sharply, attempting to solve this by raising the base rate could slow the pace of the recovering economy. If interest rates rise and existing borrowers face higher interest burdens, consumption and investment could contract.

One committee member emphasized, "Given the continued sluggishness in private consumption, employment, and inflation, it is necessary to maintain the base rate at the current level to support domestic economic recovery," and added, "It is still premature to discuss normalizing monetary policy." However, this member advised that household and corporate debt should be managed through macroprudential policies and that economic agents should be signaled to prepare for potential rate hikes. Another member stated, "Since inflation remains significantly below the target level, maintaining a clearly accommodative monetary policy will help accelerate economic improvement."

While some attribute the increase in household loans to low interest rates, others argue that factors such as housing supply and demand have driven household loan demand more than interest rates. One member said, "The rise in jeonse (long-term lease) prices has slowed, housing transaction volumes have decreased, and household loan interest rates have risen again to pre-COVID-19 levels," adding, "It seems unlikely that household loans will increase significantly going forward." Since the increase in household loans is due to housing supply and demand, it is interpreted that now is not the time to raise rates considering the current debt growth trend. There was also advice to consider the potential shock to financially vulnerable companies, as raising the base rate could increase principal and interest repayment burdens on businesses.