[1mm Financial Talk] "Effect of Loan Interest Rate Reduction is Questionable"... Why the Disclosure of Loan-Deposit Interest Rate Spread Raises Doubts

President Yoon Seok-yeol's Financial Pledge Realized in Half a Year
Effect on Lowering Loan Interest Rates Remains Uncertain

Loan Interest Rates Change Much Faster Than Deposit Rates
No Additional Rate Reduction Effect Expected with Big Step

Economic Experts Say "Banks Should Be Encouraged to Compete on Interest Rates"

[Image source=Yonhap News]

[Asia Economy Reporter Sim Nayoung] President Yoon Seok-yeol's financial pledge has been realized in just half a year. In January of this year, he said, "We will require commercial banks to periodically disclose the gap between deposit and loan interest rates," and six months later, financial authorities announced a concrete plan. As loan interest rates have been rising daily during this period of increasing rates, and banks have been posting record profits while the public has been casting sharp glances, the authorities hastened their preparations.

"From January 2015 to May of this year, the average deposit-loan interest rate spread was 1.75 percentage points, but this year, the spread has consistently exceeded 2 percentage points." (Financial Services Commission) "At the end of last year, interest income accounted for 81.8% of the total profits of seven bank groups (KB Kookmin, Shinhan, Hana, Woori, BNK, DGB, JB)." (Korea Institute of Finance) These facts formed the rationale for introducing the 'deposit-loan interest rate spread disclosure.' From this month, the public can compare the deposit-loan interest rate spreads of all domestic banks on the website of the Korea Federation of Banks.

Until now, the goal was to establish a disclosure system for the deposit-loan interest rate spread, but from now on, the key issue is how much this disclosure system can reduce the spread. The initial expectation was that this system would lower the high loan interest rates and raise the low deposit interest rates. However, even the Financial Services Commission, which created the system, has issued a conservative response.

"Going forward, the focus will be on whether loan interest rates decrease due to the disclosure of the deposit-loan interest rate spread, but objectively speaking, the spread is closely related to the difference between short-term and long-term interest rates. When the short-term and long-term interest rate gap widens, the deposit-loan interest rate spread also expands. (If the Bank of Korea raises the base rate) the short-term and long-term interest rate gap will likely widen for the time being, so it is difficult to predict a reduction in the deposit-loan interest rate spread. The disclosure will serve to control the spread from widening significantly compared to now." (Lee Hyung-joo, Director of Financial Industry Bureau, Financial Services Commission)

Banks are also reluctant. No matter how much they lower the loan margin, during a period of rising interest rates, the loan interest rates inevitably rise faster than deposit interest rates. Conversely, during a period of falling rates, loan interest rates tend to fall ahead of deposit interest rates. The cause lies in the benchmark interest rates. For mixed-type loans such as unsecured personal loans and mortgage loans (fixed rate for 5 years followed by variable rate), the benchmark is the bank bond interest rate, which changes daily or weekly. For reference, the AAA-rated 1-year bank bond interest rate rose from 2.723% on June 3 to 3.585% on July 5, an increase of 0.831 percentage points in just one month.

On the other hand, deposit interest rates use the base rate set internally by banks as the benchmark. This rate typically changes every two to three months. A representative from a commercial bank said, "The Financial Services Commission has proposed an improvement plan to reflect market interest rate changes in the base rate used to calculate deposit interest rates once a month, but even so, it is impossible for deposit interest rate changes to keep pace with loan interest rate changes." He added, "If the Bank of Korea takes a big step (raising the base rate by 0.5 percentage points at once) on the 13th, bank bond interest rates will rise, potentially widening the deposit-loan interest rate spread further."

Given the rapid rise in loan interest rates, even if banks implement measures to lower loan margins as they have recently, it will be difficult for financial consumers to feel a reduction in loan interest rates, according to banks.

In conclusion, there are limits to how much the disclosure of the deposit-loan interest rate spread can lower loan interest rates. Professor Sung Tae-yoon of Yonsei University's Department of Economics said, "While disclosing the deposit-loan interest rate spread itself is desirable, it does not significantly help in drastically lowering loan interest rates. To reduce banks' deposit-loan interest rate spreads, the monopoly structure must be broken, which can only be achieved through systems that activate interest rate competition among banks."