[Interest Rate Hike Risk] Household Loans Increased by 55 Trillion Won from January to April... "K-Shaped Polarization Will Worsen with Interest Rate Hikes"

The Biggest Obstacle to Interest Rate Hikes: 'Debt'

Significant Increase in Interest Burden May Damp Economic Recovery Momentum

Relative Burden on Vulnerable Groups Likely to Grow More Than High-Income Groups Investing with Debt

Large Corporations Face Less Pressure from Rising Interest Rates… SMEs and Self-Employed Hit Hard by COVID-19 Bear Greater Burden

K-Shaped Polarization May Worsen

[Asia Economy Reporter Kim Eun-byeol] The biggest obstacle when monetary authorities raise the base interest rate is the historically unprecedented scale of private debt. Since COVID-19, households and companies have increased their borrowing to secure emergency funds or to invest in real estate and stocks riding the wave of rising asset prices. If inflation in the third quarter, when the base effect ends, turns out higher than expected, debt issues could become a major negative factor weighing on monetary policy shifts as early as the end of this year.

Debt Burden That Hardly Decreases... Vulnerable Borrowers Face Greater Shock When Interest Rates Rise

According to the Bank of Korea on the 14th, the ratio of private credit (household + corporate debt) to GDP stood at 215.5% at the end of last year, far exceeding twice the GDP. As of the end of last year, household debt was 1,726.1 trillion KRW and corporate debt was 2,153.5 trillion KRW, and the scale of private sector loans has continued to surge this year. According to data compiled by the Financial Services Commission and the Financial Supervisory Service, household loans across all financial sectors increased by about 54.9 trillion KRW from January to April this year. Although bank household loans accounted for a large portion of the increase (36.8 trillion KRW), it is notable that loans from mutual finance (7.9 trillion KRW), insurance (4.3 trillion KRW), savings banks (3 trillion KRW), and credit finance companies (3 trillion KRW) also rose simultaneously. Since interest rates on second-tier financial sector household loans are higher and borrowers tend to have lower credit ratings and incomes, the burden when interest rates rise can be much greater.

The Bank of Korea and financial authorities believe that the proportion of vulnerable borrowers in household loans is low, so the scale is not a major problem. Vulnerable borrowers account for 6.7% of borrowers and 5.2% of loan amounts. They also claim that household loan delinquency rates have been steadily decreasing and show a healthy trend. As of the end of last year, the delinquency rate on bank household loans was 0.20%, and for non-bank household loans, it was 1.45%, significantly lower than in the first quarter of 2009 (banks 0.69%, non-banks 4.86%).

However, the burden on vulnerable borrowers cannot be ignored when interest rates rise. This is because the faster the overall debt grows, the relatively smaller the proportion of vulnerable groups becomes. A Bank of Korea official said, "While household debt is unlikely to damage the entire financial system, the problem is that groups already heavily impacted by COVID-19 feel more burdened when interest rates rise," adding, "Currently, a K-shaped recovery is observed, but this phenomenon could become more pronounced when interest rates increase."

The fact that increased household debt slows the pace of economic recovery is also problematic. The Korea Capital Market Institute pointed out in its report titled 'Changes and Challenges in Domestic and International Household Debt Due to the COVID-19 Crisis' that "the increased household debt could pose a latent risk to the overall economy, requiring timely management." They explained that increased principal and interest repayment burdens reduce consumption and savings, and if asset prices fall due to selling off held assets, it could eventually lead to financial institution insolvency.

In this situation, raising interest rates based solely on economic recovery and inflation rates could sharply increase borrowers' interest burdens and extinguish the fragile sparks of economic recovery. In particular, while high-income groups and large corporations investing with borrowed funds face almost no burden from interest rate hikes, low-income groups, SMEs, and small self-employed businesses could see their burdens rise significantly, potentially worsening the 'K-shaped recovery' after interest rate hikes.

Interest Rate Hikes → Deepening 'Rich Get Richer, Poor Get Poorer' Among Companies

Companies are no exception. According to the Bank of Korea's analysis, last year the average interest coverage ratio, which measures companies' ability to pay interest, was 4.4 times, improving from 4.1 times the previous year due to falling loan interest rates. However, excluding the electrical and electronics sector, which saw significant performance improvements due to the semiconductor boom, the average interest coverage ratio in other industries fell from 3.4 times to 3.1 times during the same period.

The proportion of companies with an interest coverage ratio below 1, meaning they cannot cover interest payments with operating profit, increased from 36.1% in 2019 to 40.7% last year. It is expected that companies in sectors already heavily impacted by COVID-19, such as airlines, accommodation, and food services, will face greater burdens as interest rates rise.

Choo Kwang-ho, Director of Economic Policy at the Korea Economic Research Institute, said, "Many sectors have yet to recover to pre-COVID-19 levels, and considering the impact on consumer sectors such as small business owners, shocks are expected when interest rates rise." The Bank of Korea also advised in its March Financial Stability Report that "if corporate interest burdens increase, the number of risky companies may rise, so when normalizing financial support measures, care should be taken to prevent credit risks in vulnerable sectors from materializing all at once."