[BOK Focus] Rapid Surge in Household Debt, Bank of Korea Says Interest Rates Are Not a Panacea

Real Estate Market Soft Landing Priority
Microscopic Measures for Cash Flow Management

"Regarding household debt, currently, a micro-level response is needed to unblock the flow of funds for the short-term soft landing of the real estate market." (July 13, Lee Chang-yong, Governor of the Bank of Korea)

As household debt, which had been slowing down, has recently turned to an increasing trend again, raising warning signs, the aftershocks of Governor Lee Chang-yong's remarks continue. On the 13th, the Bank of Korea's Monetary Policy Committee (MPC) kept the base interest rate unchanged for the fourth consecutive time following February, April, and May. This was because the outstanding household loans in the banking sector reached a record high of 1,062.3 trillion won in June, intensifying concerns over the rapid surge in household debt.

The biggest topic at the MPC was also household debt. At the press conference following the MPC, Governor Lee expressed a complex sentiment about household debt, stating that "a sophisticated policy response is necessary." He said, "Our household debt is closely related to the real estate market, so if we try to adjust it sharply in the short term, unintended side effects could be significant," citing recent issues such as real estate project financing (PF) problems, reverse jeonse difficulties, and the Saemaeul Geumgo crisis as examples.

Regarding the possibility of interest rate hikes due to household debt issues, he stated a fundamental position: "Theoretically, if we continue micro-level responses now and household debt increases more than expected, there are options to respond through not only interest rates but also by strengthening macroprudential regulations and other policies." In summary, Governor Lee’s remarks suggest that while a macro-level response to reduce the household debt-to-GDP ratio is necessary in the medium to long term, given the current situation with the real estate soft landing and the lingering effects of the Saemaeul Geumgo crisis, there is no intention to respond with interest rate hikes yet.

On the surface, Governor Lee left open the possibility of interest rate responses if household debt surges, but he emphasized that the current priority of monetary policy lies in the soft landing of the real estate market. Professor Kang Sung-jin of Korea University’s Department of Economics said, "Household debt in Korea is at the highest level among major countries relative to GDP, so it is an important consideration in monetary policy," but added, "At this point, it seems difficult to either raise or lower interest rates, so household debt did not become a key variable in this MPC."

Outstanding Household Loans in Banking Sector 'Record High'... Future Monetary Policy Variable

With growing weight on the theory that the Bank of Korea’s interest rate hike cycle has ended, household debt remains the biggest time bomb for future monetary policy. Household debt, which had been declining due to the tightening stance since August 2021 and sluggish real estate market, has turned to an increasing trend again, raising concerns. According to the Bank of Korea, as of the end of last month, outstanding household loans in the banking sector increased by 5.9 trillion won from the previous month to a record high of 1,062.3 trillion won. The increase was the largest in 1 year and 9 months since September 2021 (6.4 trillion won). Household loans in the banking sector had been declining until March this year but increased for three consecutive months through June, with a 2.3 trillion won rise in April.

The problem is that this increasing trend is likely to continue. Due to government deregulation and an increase in apartment move-in volumes, demand for home purchases and jeonse funds has risen, with housing mortgage loans in the banking sector increasing by 7 trillion won last month. This was the largest increase in 3 years and 4 months since February 2020. Governor Lee said, "MPC members also expressed many concerns about the increase in household debt." In the MPC minutes from the 21st of last month, one MPC member pointed out, "It is necessary to emphasize that the accumulation of household credit is a risk factor for our economy." There are considerable voices within the Bank of Korea expressing concern over the increase in household loans. Although Governor Lee has taken steps to coordinate with the government on the stance regarding household debt, there is also a position that the recent increase in household loans cannot be overlooked.

In fact, due to the impact of interest rate hikes since August 2021, last year Korea’s household debt burden and growth rate were the second highest among major countries worldwide. According to the Bank for International Settlements (BIS) on that day, Korea’s household sector debt service ratio (DSR) was 13.6% last year, second only to Australia (14.7%) among 17 major countries surveyed worldwide.

Following Australia and Korea, Canada (13.3%), the Netherlands (13.1%), Norway (12.8%), Denmark (12.6%), and Sweden (12.2%) had DSRs exceeding 10% as of last year. BIS publishes quarterly DSRs for 17 countries calculated using national accounts. The DSR indicates the burden of debt principal and interest repayments relative to income; a higher DSR means a greater repayment burden compared to income.

Korea’s household debt growth rate was also the second fastest among major countries. Korea’s DSR last year rose by 0.8 percentage points compared to 2021 (12.8%), ranking second after Australia, which increased by 1.2 percentage points from 13.5% to 14.7%. Canada rose by 0.7 percentage points (12.6→13.3%), the U.S. by 0.4 percentage points (7.2→7.6%), Finland by 0.3 percentage points (7.2→7.5%), and Japan by 0.1 percentage points (7.4→7.5%), indicating increased repayment burdens. Meanwhile, among the 17 countries surveyed, 9 saw their DSRs decline last year.

Professor Kim Jung-sik, Emeritus Professor of Economics at Yonsei University, emphasized, "Excessive debt increases the burden of principal and interest repayments, reducing households’ real disposable income and shrinking private consumption," adding, "Since the accumulation of household debt acts as a downside risk to growth in the medium to long term, timely government responses are necessary." In April, the Bank of Korea stated in its 'BOK Issue Note - Analysis of Household Credit Accumulation Risks and Policy Implications' that "In situations like Korea’s, where the household credit ratio already exceeds 100% of GDP, the negative spillover effects of household debt on the macroeconomy are likely to be greater," and stressed, "It is important to reduce household debt so that the household credit ratio approaches 80%."

Professor Yoo Hye-mi of Hanyang University’s Department of Economics and Finance said, "Although the increase in household debt is a burden for the Bank of Korea, the real estate market is only stirring around Seoul and apartments; the situation for commercial real estate and others has not improved," and diagnosed, "Since base interest rate hikes affect the entire market, it will be difficult to raise rates as the gap between Seoul and other regions widens and conditions become tougher."

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