The Bank of Korea: "High Income, High Debt Ratio, and Non-Vulnerable Borrowers Show High Interest Rate Sensitivity"

Real estate stock photo / Photo by Mun Ho-nam munonam@

[Asia Economy Reporter Seo So-jeong] Since the second half of last year, as the base interest rate hike has intensified, sensitivity to interest rate increases has been analyzed to be greater among those with higher income, higher debt-to-income ratio, younger age, and non-vulnerable borrowers. This is because these groups have a higher proportion of loans for real estate purchases and business funds, while the proportion of loans for living expenses is lower.

On the 30th, the Bank of Korea stated in its report "Analysis of Interest Rate Sensitivity of Household Loans and Implications" that "those with higher income levels and debt-to-income ratios (based on LTI), and non-vulnerable borrowers respond more sensitively to interest rate changes."

According to the Bank of Korea, sensitivity to interest rates was higher during periods of rising rates than during falling rates. Since the global financial crisis, when loan interest rates rise by 1 percentage point, household loan fluctuations shrink by 26.8 trillion won, whereas when rates fall, the expansion is only 13.8 trillion won, indicating higher interest rate sensitivity of household loans during rate hikes. Additionally, the widening gap between asset price growth rates and loan interest rates after COVID-19 has increased household leverage investment, which also contributes to higher interest rate sensitivity of household loans during rate hikes.

By income level, high-income borrowers responded sensitively to interest rate changes, while middle- and low-income borrowers were relatively insensitive. The response coefficient for the net asset return variable was 1.27 for high-income borrowers, 3 to 5 times higher than for middle- and low-income borrowers, indicating that high-income borrowers tend to increase loans significantly more than middle- and low-income borrowers when net asset returns rise. In particular, high-income borrowers generally have good credit ratings, making loan accessibility high, and they tend to have a higher proportion of loans for investment purposes requiring large sums (such as real estate purchases and business funds).

Looking at borrowers by debt-to-income ratio (LTI) levels, those with high leverage showed a tendency toward higher interest rate sensitivity. Estimation results showed that from borrowers in the top 60% of LTI and above, sensitivity to interest rates increased as the debt ratio rose. The response coefficient for net asset returns was 2.56 for the 8th to 10th LTI deciles, up to twice as high as for the 5th, 6th, and 7th to 10th deciles. This means that highly leveraged borrowers also respond more sensitively to net asset returns.

However, vulnerable borrowers were estimated to be less sensitive to interest rate changes than non-vulnerable borrowers. The Bank of Korea explained, "Among vulnerable borrowers, the proportion of living expense-type and credit loans, as well as other loans and non-bank loans with low interest rate sensitivity, is high," and added, "By sector, non-bank loans and, by loan type, other loans were found to be relatively insensitive to interest rate changes."

By age, younger groups in their 20s to 40s showed higher interest rate sensitivity than older groups. Sensitivity to net asset returns was also highest among those in their 20s and 30s, with an estimated coefficient of 1.08, indicating that sensitivity increases as age decreases.

The Bank of Korea emphasized, "Although the proportion of living expense loans in total household debt is small, it is important to note that vulnerable groups such as low-income, elderly, and vulnerable borrowers with many living expense loans have low interest rate sensitivity, which limits the slowdown in loan growth even when interest rates rise."

It added, "On the contrary, when interest rates rise, the debt repayment burden for vulnerable groups increases relatively more, raising the risk of default. If this risk materializes, it could lead to a deterioration in asset soundness of non-bank financial institutions that have a high proportion of loans to vulnerable groups. While continuing policy efforts to curb the accumulation of household debt, it is necessary to closely prepare for the possibility of increased credit risk in the vulnerable sector."