Before Small Business Owners' Insolvency, Shinbo Repays Guaranteed Debt... Controversy Over 'Moral Hazard'

Financial Services Commission Announces Partial Amendment to the Enforcement Decree of the Credit Guarantee Fund Act
Revision Allows Credit Guarantee Fund to Repay Debt Even if Not Insolvent
"90-100% Guarantee Products Too"... Concerns Over Moral Hazard
Unclear Support Targets and Product Criteria Also Problematic

[Asia Economy Reporter Song Seung-seop] The government will provide early debt restructuring for guaranteed loans to small business owners and self-employed individuals who have been struggling due to COVID-19. Even if the business operator's management normalization is difficult, the Korea Credit Guarantee Fund (KODIT) will repay the loan on their behalf if there is a possibility of difficulty in the future. Critics argue that this could ignite moral hazard controversies recently raised in the financial sector.

According to the financial sector on the 22nd, the Financial Services Commission announced the legislative notice of the 'Partial Amendment to the Enforcement Decree of the Korea Credit Guarantee Fund Act' the day before. The amendment added new conditions to Article 22, 'Special Cases for Guarantee Debt Performance Claims.' It includes a legal basis for fulfilling guarantee debt obligations of small business owners and self-employed individuals before the loan becomes non-performing. Unlike before, it means that KODIT will repay the debt on behalf of small business owners and self-employed individuals even if they have not yet reached the point where management normalization is difficult.

KODIT is an institution that provides guarantees so that companies with weak collateral or credit can smoothly borrow money from financial institutions. Since financial companies are repaid by KODIT in case of loan defaults, they also lend to small business owners and self-employed individuals with low credit ratings. Under current law, financial companies can only request KODIT to repay the money if it is clear that management normalization is difficult due to bankruptcy, dissolution, or closure of the small business owner or self-employed individual.

The Financial Services Commission stated that this amendment establishes a legal basis for the 'COVID-19 Affected Small Business Owners and Self-Employed Debt Adjustment Program (New Start Fund).' It explained that rapid debt restructuring has become possible as KODIT can repay the debts of borrowers at risk of default before actual defaults occur.

KODIT’s Deep Concern... Must Repay Debt on Behalf Even with Only Default Risk

The problem is moral hazard. Among KODIT’s guarantee products, many have guarantee ratios reaching 90-100%. Once the amendment is implemented, in principle, KODIT must repay most of the money simply because there is a risk of default. After the Financial Authorities announced the New Start Fund, communities of self-employed individuals have posted self-deprecating messages such as "Those who diligently repay their debts are fools."

The criteria for exactly who qualifies as a borrower at risk of default are also unclear. The amendment only states, "In cases where the Financial Services Commission recognizes the necessity of rapid guarantee debt performance for national policy reasons." Typically, banks consider non-performing loans as those overdue for 60 to 90 months. Considering the policy implementation date, some small business owners who fall under the at-risk category might deliberately avoid repayment and wait until they become non-performing borrowers.

It is known that KODIT is deeply concerned about this policy. With limited budgets, they must repay the debts of more small business owners and self-employed individuals, but it is difficult to decide whom and how to support. As of the end of June this year, KODIT’s guarantee scale reached 60 trillion won, of which the 'Small Business Entrusted Guarantee' program, started in May 2020, accounts for 7 trillion won. If early repayment begins, the subrogation repayment rate will inevitably soar.

Voices expressing concern about the government’s policy have already emerged from regional credit guarantee institutions. On the 19th, Lee Sang-hoon, Chairman of the Korea Credit Guarantee Foundation, appealed, "To reduce risks when supporting the management normalization of small business owners affected by COVID-19, the basic assets of regional credit guarantee institutions must be increased."