[Interest Rate Hike] Household Debt Interest Up by 3.1 Trillion Won... Increased Burden on Vulnerable Borrowers and Marginal Companies

Among Household Loans of 1,705.3 Trillion KRW, Variable Interest Rate Accounts for 72.7%

Interest Burden Increases by 3.1 Trillion KRW with 0.25%p Rate Hike

Delinquency Rate of Vulnerable Borrowers Rises by 2.0%p upon Rate Increase

Countermeasures Needed for Marginal Companies and Self-Employed

Mortgage and Credit Loan Benchmark Interest Rates Already Rising

Close Watch on Mortgage Loan Rate Impact from Next Month's COFIX Increase

[Asia Economy Reporters Eunbyeol Kim, Hyojin Kim, Sehee Jang] With the Bank of Korea's decision on the 26th to raise the base interest rate, the interest burden on existing borrowers is expected to increase. As household debt has grown to around 1,800 trillion KRW and financial institutions such as banks are likely to raise loan interest rates consecutively, the burden is expected to concentrate on the self-employed, low-income households, vulnerable groups, and marginal companies.

According to the Bank of Korea, if the base rate hike (0.25 percentage points) is fully reflected in loan interest rates, the total interest burden for all households in South Korea is expected to increase by approximately 3.1 trillion KRW. As of the end of Q2, the household credit balance (1,805.9 trillion KRW) excluding sales credit (credit card usage before payment) amounts to 1,705.3 trillion KRW in loans, considering that the proportion of variable interest rate loans was 72.7% as of the end of June. Previously, the Bank of Korea reported to the National Assembly that a 1 percentage point increase in household loan interest rates would raise interest burdens by 11.8 trillion KRW.

Delinquency Rate of Vulnerable Borrowers Rises by 2.0 Percentage Points

In particular, the debt burden on vulnerable borrowers?those with multiple debts (borrowed from three or more financial institutions) who are either low-income (bottom 30% income) or have low credit scores (664 points or below), and a debt service ratio (DSR) of 70% or higher?is increasing further. It is pointed out that the delinquency rate of vulnerable sectors is more sensitive to market interest rate fluctuations compared to non-vulnerable sectors. Vulnerable borrowers originally face heavy debt repayment burdens, hold a high proportion of variable interest rate loans, and experience a rapid rise in risk premiums reflecting credit risk when interest rates increase, which intensifies their interest repayment burden.

According to the Bank of Korea's Financial Stability Report from June, analyzing past interest rate hike periods (Q4 2016 to Q1 2019), the delinquency rate of vulnerable borrowers rose from 6.4% to 8.4%, an increase of 2.0 percentage points. This contrasts with the non-vulnerable borrowers whose delinquency rates remained unchanged during the same period. The delinquency rate of high-DSR vulnerable borrowers also increased by 0.3 percentage points during this period.

The burden on insolvent companies that relied on low interest rates and government support is also inevitably increasing. According to the Bank of Korea and others, vulnerable small and medium enterprises (SMEs) that cannot even properly pay interest account for more than half of all SMEs. Among 1,244 SMEs that disclosed business reports last year, 50.9% had an interest coverage ratio (operating profit/total interest expense) below 1. Considering that this ratio was 39.6% in 2015, it has expanded by more than 11 percentage points over five years.

Professor Donghyun Ahn of Seoul National University’s Department of Economics said, "The problem is that when interest rates rise, the burden on vulnerable groups increases more than the slowdown in growth rate," adding, "It is an issue that the government, including the Financial Services Commission, should address through policy responses."

Mortgage Loan Benchmark Interest Rates on the Rise

Attention is focused on when financial institutions such as banks will reflect the base rate hike in loan interest rates. Market interest rates had already partially anticipated the possibility before the Bank of Korea’s rate hike. The mixed-type mortgage loan interest rate often follows the 5-year bank bond rate as a benchmark, and the 5-year (AAA, unsecured) bond rate rose from 1.277% at the end of July last year to 1.923% as of the day before. The 1-year (AAA, unsecured) bank bond rate, used as a benchmark for credit loans, also increased from 0.761% to 1.263% during the same period, rising by more than 0.5 percentage points. The COFIX rate based on new contracts rose from 0.81% to 0.95% during this period.

Professor Ahn said, "Market interest rates preemptively reflected the rate hike as Bank of Korea Governor Lee Ju-yeol hinted at further increases within the year," adding, "Market interest rates will move depending on inflation levels and the possibility of additional rate hikes." He added, "This time it may not have a large impact, but it will be affected depending on the timing of further rate hikes."

The banking sector is taking a cautious stance for the time being. A representative from a commercial bank said, "There will be no noticeable changes in deposit and loan interest rates immediately," noting that the increase had already been pre-reflected in government bonds and bank bonds. However, there is speculation that the COFIX rate may continue to rise next month, which could affect mortgage loan rates. The representative explained, "There is a possibility that COFIX will rise next month, and since this affects mortgage loans, it is necessary to keep an eye on it."

"Focus on Loan Policies Rather Than Interest Rates"

Regarding the overall trend in the loan market, some voices suggest paying more attention to the direction of loan policies that financial authorities will pursue in the future rather than interest rate hikes. Another bank official said, "From a broad perspective, it is hard to say that the base rate hike significantly affects liquidity," adding, "Loan flows related to 'debt investment' or 'all-in borrowing' will ultimately be more influenced by government actions."

Go Seung-beom, nominee for Financial Services Commission Chairman, stated in a written response submitted to the National Assembly’s Political Affairs Committee the day before, "We will strongly promote the previously announced household debt management measures, continue efforts to enhance their effectiveness, and actively discover and implement additional measures using all available policy tools if necessary." A financial sector official said, "Regardless of the Bank of Korea’s decision, some banks may adjust deposit interest rates according to the authorities’ intentions."