[BOK Focus] Bank of Korea Tackles Real Estate... "Low Added Value, Lending Should Be Tightened"

Signs of Real Estate Rebound... Bank of Korea Raises Household Debt Concerns
"Weak Productivity Improvement, but Loan Funds Concentrated"
Need for Loan Regulations from Resource Allocation Efficiency Perspective
Include Jeonse Loans in DSR and Adjust LTV, etc.

The Bank of Korea has recently voiced repeated warnings about the real estate market, which is showing signs of a rebound. As the high-intensity tightening monetary policy nears its end and warning signs about the increase in household debt are reappearing, it is interpreted that the Bank is raising concerns by targeting real estate-related loans, which are the core cause.

The Bank explained that since the real estate industry has a slower productivity growth rate compared to other industries and significantly impacts the worsening household debt ratio, it is necessary to strengthen regulations to reduce the flow of funds to this sector. One representative example is the jeonse (long-term lease) loan, which is less regulated compared to major countries.

Low Productivity but Excessive Fund Concentration in 'Real Estate'

According to the Bank of Korea, the real estate industry is considered a representative sector where the concentration of funds is excessively high compared to the rate of productivity improvement. Since 2002, the real value-added of the real estate industry has shown moderate growth compared to major industries such as manufacturing, professional science, and electrical equipment, but the concentration of loans has risen more steeply than other industries since 2015.

According to a report released on the 17th by Deputy Research Fellow Lee Kyung-tae of the Bank's Economic Research Institute and Kang Hwan-gu of the Monetary Policy Research Office, as of last year, the real estate industry received loan funds more than twice the proportion of its share in the Gross Domestic Product (GDP), whereas other major industries such as manufacturing and professional science received loan funds similar to or slightly less than their GDP share.

A Bank of Korea official explained, "Usually, industries with low real value-added do not receive much funding, but an unusually large amount of funds is concentrated in the real estate industry," adding, "This means that more than twice the amount of money is flowing in compared to the value it creates."

From the perspective of the overall efficiency of national resource allocation, the Bank explained that it is necessary to reduce the concentration of real estate-related loans so that appropriate funds can be invested in industries with faster productivity improvement than the real estate sector.

This is not the first time the Bank has targeted the excessive concentration of funds in the real estate industry.

Earlier, Kim In-gu, Director of the Financial Stability Bureau at the Bank of Korea, said at a joint forum of the National Economic Advisory Council and the Korean Economic Association on the 23rd of last month, "Loans are not going to sectors with high productivity," and added, "To improve capital efficiency, funds flowing into real estate should be redirected to more productive sectors."

Also, Lee Chang-yong, Governor of the Bank of Korea, said at a press conference following the Monetary Policy Committee meeting on the 13th, "If real estate prices rise mainly in the metropolitan area and household loans increase further, it will be problematic," and explained, "To reduce the household debt ratio relative to GDP to around 80% in the medium to long term, it is necessary to go through a process of revising real estate-secured loans."

"DSR Should Include Jeonse Loans"…Repeated Emphasis

The Bank of Korea sees the need to strengthen the Debt Service Ratio (DSR) regulation to improve the concentration of funds in real estate.

The DSR regulation limits the borrower's annual principal and interest repayment amount to a certain percentage of their annual income. Currently, this standard is 40% in South Korea. For example, if a debtor has an annual income of 50 million KRW, the principal and interest repayment in a year should not exceed 20 million KRW.

The problem is that jeonse loans and interim payment loans are excluded from the DSR principal and interest calculation. As a result, before the interest rate hike period, jeonse loans increased significantly, causing jeonse prices in the metropolitan area to rise rapidly. From an individual's perspective, even if they take out a jeonse loan, they can still borrow other credit loans up to the limit, which contributed to the surge in household loans.

The report advises that jeonse loans, as well as moving expenses and interim payment loans, should all be included in the DSR regulation. A Bank official explained, "Most countries include all loans without exception in the DSR calculation, and only a few countries exclude student loans," adding, "South Korea also needs to gradually reduce the exceptions."

In the Financial Stability Report released in December last year, the Bank also suggested, "Considering that jeonse loans have been partially used as gap investment funds, acting as a factor in housing price increases and housing market volatility, it is necessary to apply DSR regulations partially to jeonse loans."

Jeonse Loans Driving Up House Prices... 'Need Gradual Improvement'

Since the jeonse system hardly exists abroad, it is difficult to compare directly with South Korea, but even considering this, there are many criticisms that regulations on jeonse loans are weak and the beneficiary scope is excessively broad in South Korea.

In fact, until before 2009, the guarantee limit for jeonse loans was only about 100 million KRW, but now it has increased to 400 million KRW according to the Korea Housing Finance Corporation. While there is a strong voice that the increase in the guarantee limit was inevitable due to the rapid rise in jeonse prices during the same period, conversely, this structure allowing excessive jeonse loans has also contributed to driving up jeonse and sale prices.

A Bank of Korea official pointed out, "If the guarantee limit is low, the number of beneficiaries of jeonse loans is small, which improves their housing services, but if the beneficiary scope becomes excessively broad, everyone's jeonse purchasing power rises, causing jeonse prices to rise quickly," adding, "Then, the gap between sale prices and jeonse prices narrows, creating incentives for leveraged investment, which in turn pushes up housing prices."

In particular, South Korea's Loan-to-Value (LTV) regulation, which sets the limit on mortgage loans relative to housing prices, is stronger compared to major countries, leading to an analysis that loan demand concentrates on jeonse rather than housing sales. Therefore, there are opinions that LTV regulations should be partially eased while strengthening jeonse regulations such as DSR to disperse jeonse demand into sales.

Although the Bank of Korea has repeatedly expressed concerns about the increase in household loans driven by the real estate market, the possibility of immediate changes in loan regulations is low. This is because the government has recently taken opposite steps, such as easing some real estate loan regulations to supply liquidity amid growing reverse jeonse problems. In the real estate market, there are also strong voices that regulations rather cause house price increases and that DSR regulations should be eased.

The Bank also holds the view that rather than reforming the system in the short term, a process of improvement with other real estate-related systems over time is necessary. For example, among those renting jeonse, some postpone buying a house while waiting for subscription opportunities, so tightening jeonse loans abruptly could harm some people.

A Bank official said, "If subscription and other systems are not revised together, it is not easy to disperse jeonse loan demand," adding, "A comprehensive review is needed. In the short term, what can be done is to gradually reduce exceptions in the DSR with some time lag."