Banking Sector to See Significant Increase in Loan Loss Provision Expenses Next Year

[Asia Economy Reporter Song Hwajeong] It has been revealed that the provision levels for loan losses by domestic banks are lower compared to overseas banks, and there is a forecast that loan loss expenses will rise significantly next year.

On the 29th, according to Ebest Investment & Securities, a comparison of loan loss expense ratios (provision ratio against total loans) among major banks in Korea, the United States, Europe, and Japan showed that Korea, along with the U.S., had minimal increases in loan loss expense ratios during the COVID-19 period. The final increase in loan loss expense ratio for major U.S. banks during the COVID-19 phase was 3bp (1bp = 0.01 percentage points), while the average for the four major Korean banks was 8bp. The UK recorded 17bp, Europe 35bp, and Japan 24bp.

In the case of the U.S., among major advanced countries, the economic growth decline in 2020 was the smallest despite the COVID-19 shock, and a strong economic recovery was observed last year. Therefore, it is analyzed that it is difficult to expect domestic banks to record as low a final loss scale as U.S. banks. Jeon Baeseung, a researcher at Ebest Investment & Securities, stated, "Although borrowers' financial soundness deteriorated significantly during the economic downturn, the final loss recognition scale compared to overseas banks such as those in Europe and Japan is judged to be remarkably low, so the burden of COVID-19 related provisions for domestic banks will continue in the future." Jeon also predicted that if the final increase levels of loan loss ratios of overseas banks during the COVID-19 phase are directly applied to domestic banks, there will be at least a 10 to 20bp upward pressure on loan loss expenses.

The Bank of Korea also recently expressed concerns in its Financial Stability Report that if future financial support measures end, potential credit losses may materialize, leading to increased loan loss expenses and a decline in capital adequacy ratios for banks. According to the report, the provision levels related to loan losses by domestic banks during the COVID-19 period were only at the 25th to 45th percentile of the credit loss distribution, falling short of expected losses. This is significantly lower compared to the 75th to 95th percentile provision levels during the 2008 global financial crisis.

Moreover, considering the recent economic situation, the burden of loan losses is expected to continue rising. This is due to the steep rise in loan interest rates accompanied by inflationary pressures and growing concerns about economic slowdown. An environment where inflationary pressures expand and interest rates rise sharply, as seen recently, inevitably reduces households' real income and worsens corporate profitability, negatively impacting the overall financial soundness of bank borrowers.

In particular, loan loss expenses are expected to rise significantly starting next year. Researcher Jeon said, "Since the grace period has been extended until September this year and the maturity of financial support programs by commercial banks is scheduled for early next year, the full-scale increase in loan loss expenses will occur in 2023," adding, "Even in the second half of 2022, as new non-performing loans expand, it will be difficult for the loan loss ratio to decrease from the current level, and the financial authorities may continue to require additional provisions for COVID-19 related loans."