The Bank of Korea "Will Consider Expanding the Scope of DSR Application When Household Debt Increases" [Q&A]

Bank of Korea Holds June Financial Stability Report Press Briefing
Considers Expanding DSR Application Range if Household Debt Increases
Appropriate Household Debt Level Relative to GDP is in the 80% Range

[Image source=Yonhap News]

The Bank of Korea stated that if the household debt growth trend expands in the future, it may broaden the scope of the Debt Service Ratio (DSR) application. They intend to reduce the exceptions excluded from DSR application, such as policy finance.

On the 26th, the Bank of Korea held a press briefing after publishing the 'Financial Stability Report for the First Half of the Year' and made these remarks. Jang Jeong-su, Director of the Financial Stability Bureau at the Bank of Korea, said, "We are very cautious about managing household debt together with the government, and the principle remains unchanged," adding, "Along with the implementation of the second phase of the stress DSR in September, there is also a means to expand the scope of DSR application if necessary."

Regarding the appropriate level of household debt relative to Gross Domestic Product (GDP), he mentioned that it is appropriate to lower it to the 80% range. Director Jang said, "Even though the household debt ratio to GDP has decreased due to the revision of the base year, it is still at a very high level globally compared to other countries," and added, "We need to achieve a downward stabilization in the medium to long term."

The following is a Q&A session with Deputy Governor Lee Jong-ryeol and Director Jang Jeong-su of the Financial Stability Bureau.

- There have been concerns recently about rising delinquency rates in the secondary financial sector. Is there a possibility that this risk could spread to other financial institutions like banks or to the industrial sector?

▲Jang Jeong-su, Director of Financial Stability Bureau: Overall, the resilience of financial institutions is good, but we need to be cautious about the increase in asset quality issues, especially delinquency rates. In particular, the delinquency rate in the non-bank sector is rising, with increases among self-employed individuals, especially vulnerable borrowers, and in real estate project financing (PF) related delinquencies. Both the Bank of Korea and policy authorities have prepared measures regarding this, and in May, a soft landing plan for real estate PF was established. It is crucial to implement these measures without fail. Currently, I believe the possibility of this spreading into a systemic risk in the financial sector is low.

▲Lee Jong-ryeol, Deputy Governor: Stress tests also show that the non-bank sector has a good level of loss absorption capacity and liquidity response ability. Under the current circumstances, the likelihood of spreading into systemic risk is low and is considered manageable.

- The Financial Stability Report at the end of last year mentioned that already announced measures, such as the introduction of stress DSR, must be implemented without delay. How do you view the recent postponement of the second phase of stress DSR implementation by the Financial Services Commission? Do you think policy coordination between the Bank of Korea and the authorities is being conducted closely?

▲Deputy Governor Lee: Currently, the risk factors we are concerned about include the increased debt repayment burden on vulnerable borrowers and concerns about real estate PF defaults. I understand that the policy authorities share these concerns. They are currently preparing support measures for vulnerable groups, and considering the ongoing restructuring of real estate PF, a slight fine-tuning has been made.

▲Director Jang: The Financial Stability Bureau continues to discuss household debt issues with the policy authorities.

- You mentioned the need for thorough risk management by industry regarding corporate credit. Which industries are you focusing on?

▲Director Jang: The reason for emphasizing industry-specific risk management in corporate credit is that not only household debt but also corporate debt has increased significantly recently. In particular, loans related to real estate have increased substantially, and delinquency rates have also risen. Financial institutions need to pay special attention to risk management. Going forward, it is necessary to manage so that funds do not flow into specific sectors, especially those with low productivity.

▲Deputy Governor Lee: The postponement of the DSR implementation does not mean a change in the household debt management stance. We share the same view with the policy authorities that the household debt management regulations remain unchanged and that the household debt growth rate should be stably managed within the range of GDP growth.

- Recently, housing price sentiment has improved, and housing prices in the metropolitan area are rising. How do you view concerns that if interest rates are lowered in the future, the household debt growth trend might accelerate?

▲Deputy Governor Lee: There is significant concern that household debt will increase further as housing prices have started to rise, especially in some areas of Seoul, in addition to expectations of interest rate cuts. However, whether this is a fundamental upward trend needs to be observed over more time. Appropriate measures will be taken if necessary, and we are continuously discussing this with financial authorities.

▲Director Jang: Together with the government, we are very cautious about managing household debt, and the principle remains unchanged. Recently, household debt has increased, and housing transactions have risen. Policy finance has also increased. We are carefully monitoring all these factors and, if necessary, along with implementing the second phase of stress DSR in September, we have means to expand the scope of DSR application. We will manage household debt under the principle of keeping the ratio within nominal GDP growth.

- Regarding risks in non-bank financial institutions, you assumed a rapid increase in non-performing assets. From the financial authorities' perspective, what factors are expected to cause a rapid increase in non-performing assets? Also, does the liquidity event mentioned in the report refer to a bank run (massive deposit withdrawals)?

▲Director Jang: A representative example of a liquidity event is the 2020 Legoland incident. Due to increased real estate PF default risk from the Legoland incident, securities firms faced difficulties in raising funds in the short-term financial market. A bank run can also be included. The focus of this analysis is that there are two major risks to be cautious about from a financial stability perspective. One is the credit risk where capital ratios decline significantly, and the other is liquidity risk, where capital ratios are not problematic but financial entities' sentiment deteriorates, causing increased concerns about a specific financial institution, leading to a surge in withdrawals like the Saemaeul Geumgo incident last year. This stress test checked capital adequacy, and the liquidity test assessed liquidity risk.

- You mentioned there are means to expand the scope of stress DSR application. Does this mean a phased, step-by-step expansion, or that there are additional ways to further broaden the scope beyond the existing plan?

▲Director Jang: Stress DSR involves adding a margin rate when financial institutions set loan limits for borrowers. Expanding the scope of DSR application means reducing the exceptions to DSR. If household debt increases significantly, one measure under consideration is to broaden the range of subjects to whom the limits apply.

- After the revision of the base year, what is considered the appropriate standard for the household debt ratio relative to GDP?

▲Deputy Governor Lee: The appropriate level of household debt ratio is generally discussed around the 80% range. Lowering it to the 80% range would overall benefit our economic situation.

▲Director Jang: The household debt ratio is basically stabilizing downward. However, it is true that household debt has recently increased, so we are watching it closely. Even though the target of 100% has been achieved, it does not mean we can manage household debt more loosely. Even if the ratio has decreased due to the GDP revision, it remains very high globally compared to other countries. We believe medium to long-term downward stabilization is necessary.