[Bank of Korea Financial Stability Report] Financial Vulnerability at Crisis Level... Housing Prices May Plummet

Financial Vulnerability Index Hits Highest Since Financial Crisis
Housing Prices Overvalued Mainly in Seoul Area... Could Drop Sharply

[Asia Economy Reporter Eunbyeol Kim] As private debt has surged sharply since the COVID-19 pandemic, the Bank of Korea has publicly warned that "the financial system has become vulnerable." The Bank stated that with the clear rise in risk appetite due to monetary easing and the significant increase in debt, the risk of the financial system being shaken has grown even after escaping the COVID-19 crisis. In particular, the ratio of private credit to nominal Gross Domestic Product (GDP) stands at 216.3%, far exceeding twice the GDP, and the high likelihood of interest rate hikes this year further supports the Bank of Korea's warning.

According to the "2021 First Half Financial Stability Report" released by the Bank of Korea on the 22nd, the Financial Vulnerability Index (FVI), which comprehensively assesses financial system vulnerability and resilience, recorded 58.9 (provisional) in the first quarter of this year, higher than 41.9 in the fourth quarter of 2019 before the spread of COVID-19. This is the highest level since the fourth quarter of 2008 (60.0), right after the financial crisis, indicating that Korea's financial vulnerability has risen to levels comparable to those during the financial crisis. The FVI is an index ranging from 0 to 100 that comprehensively considers the degree of financial imbalance and the resilience of financial institutions, indicating the vulnerability of the financial system to domestic and external shocks. A higher value means a greater potential negative impact on finance and the economy when shocks occur.

The Bank of Korea explained, "Although short-term financial instability following the COVID-19 crisis has been resolved, potential vulnerabilities within the financial system from a medium- to long-term perspective have rather expanded," adding, "Financial imbalances have accumulated due to increased risk appetite driven by continued accommodative financial conditions and asset price rises linked to private credit expansion." It particularly pointed out that the increased tendency to seek returns through risky assets such as stocks and real estate is problematic. The Bank said, "Some asset prices are likely overvalued," and "When evaluating housing prices through key statistical indicators such as long-term trends and the price-to-income ratio (PIR), overvaluation is evident, especially in the Seoul area." It also warned that if the Korean economy experiences domestic or external shocks amid accumulated financial imbalances, housing prices could fall sharply.

The Bank of Korea estimates that the domestic cryptocurrency (asset) market capitalization reaches about 50 trillion won. Lee Jung-wook, Director of the Financial Stability Department at the Bank of Korea, said, "The price volatility of crypto assets is a result of excessive risk-taking behavior," adding, "Although smaller than the stock market capitalization (3,000 trillion won), the risk probability is high, so vigilance is necessary."

If financial imbalances deepen, domestic and external shocks could negatively impact the real economy. According to the Bank of Korea's stress test results, in extreme cases, the current level of financial imbalance carries an inherent risk of GDP growth falling below -0.75% (annualized basis).