[Song Seungseop's Financial Light] Why Has 'Gojengiha Yosin' Become a Key Indicator?

Finance is difficult. It is filled with confusing terms and complex backstories intertwined. Sometimes, you need to learn dozens of concepts just to understand a single word. Yet, finance is important. To understand the philosophy of fund management and consistently follow the flow of money, a foundation of financial knowledge is essential. Therefore, Asia Economy selects one financial term each week and explains it in very simple language. Even if you know nothing about finance, you can immediately understand these ‘light’ stories that illuminate the ‘light’ of finance for you.

[Asia Economy Reporter Song Seungseop] The growth of banks is based on deposits and loans. They supply money where it is needed and earn profits by receiving interest. Therefore, banks have to be meticulous in managing loans. They must carefully consider how much to lend to those who want loans. The same applies after the loan is executed. They need to manage when the money will be repaid and whether the borrowed money might be defaulted on.

However, not all loans are the same. Suppose A and B, who have the same credit score, each borrowed 100 million won. A failed to pay the loan interest for one month. Unexpected expenses arose, and A lacked the money to pay the interest. B, on the other hand, has not paid loan interest for a year. Their phone is off, and they have completely disappeared. Although the money was lent under equal conditions, it is difficult to recover the money from B. Banks must prepare for the possibility that loan recovery may be difficult.

Therefore, banks classify the lent money into five categories for management: Normal, Watch, Substandard, Doubtful, and Estimated Loss. Normal refers to loans given to people with good credit status. The overdue period is less than one month, and interest has been steadily received. These are sound loans with almost no risk of default. Watch refers to loans with an overdue period of less than three months, and there is still some possibility of recovery.

The problem lies with Substandard, Doubtful, and Estimated Loss. From Substandard and below, the probability of not recovering the loan increases. Substandard loans are those overdue for more than three months. Doubtful loans have an overdue period of 3 months to 1 year, and Estimated Loss loans are overdue for more than 1 year. Especially, Doubtful loans are expected to incur losses, but the amount of loss is difficult to determine. Estimated Loss loans are practically unrecoverable, and the loss can be identified, making it inevitable to record the loss in the accounting books.

The categories Substandard, Doubtful, and Estimated Loss combined are called ‘Non-performing loans below Substandard.’ The proportion of these non-performing loans in the total loan amount is called the ‘Non-performing loan ratio below Substandard.’ If this ratio is high, the bank’s survival is at risk. The more money that cannot be recovered, the more the bank loses customers’ deposits. This is why depositors tend to avoid banks with a Non-performing loan ratio below Substandard exceeding 8%.

Recently, the Non-performing loan ratio below Substandard has been receiving more attention. Last year, due to COVID-19, the economy worsened, and many people took out loans, but the economic recovery has been slower than expected. Loans start to be repaid only when the economy recovers, but small and medium-sized enterprises, small business owners, and vulnerable groups do not have the capacity to do so. On the contrary, indicators such as the business closure rate are rising, worsening the situation. Non-performing loans below Substandard inevitably increase. Especially, the second-tier financial sector, which has many financially vulnerable groups, has seen an increase in this scale.

Moreover, the maturity of COVID-19 loans has been extended, and interest repayments have been deferred. This measure was supposed to end in April but has been extended until September. All loans that have been extended and deferred in this way are classified as ‘Normal’ by financial authorities. In reality, they could be non-performing loans below Substandard with a high possibility of default. This is why we cannot be reassured that the Non-performing loan ratio below Substandard is still sound.