Bank of Korea "Concerns Over Rising House Prices and Household Debt Due to Interest Rate Cuts... Proactive Management Is Important"

Concerns Over Rising House Prices and Household Debt Due to Base Rate Cut
Proactive Government Policies Needed to Reduce Financial Vulnerability
Bank of Korea Financial Stability Report

The Bank of Korea has issued a warning that proactive macroprudential management is crucial as negative effects such as rising housing prices and increasing household debt may intensify due to future base rate cuts.

According to the Financial Stability Report released by the Bank of Korea on the 26th, concerns about the accumulation of financial imbalances have grown amid rising housing prices in the Seoul metropolitan area and a high growth rate of household debt, along with interest rate cut decisions by major countries including the United States.

The Bank of Korea found that since 2000, when loan interest rates fall by 0.25 percentage points, the nationwide housing price growth rate increases by 0.43 percentage points after one year, with Seoul showing a rise of 0.83 percentage points?about twice the national average increase.

In fact, since the second quarter of this year when market interest rates sharply declined, housing sale prices have continued to rise mainly in Seoul and the metropolitan area. As of last month, more than 15 autonomous districts in Seoul recorded weekly price increases exceeding 0.2%. Recently, signs of price increases spreading to Incheon and Gyeonggi Province in the metropolitan area have also appeared.

The report pointed out that in this process, the growth rate of private credit may exceed the economic growth rate, increasing pressure on the household debt-to-GDP ratio. With housing sales transactions rising mainly in Seoul apartments, household loans in the financial sector have rapidly increased since the second quarter of this year, primarily in mortgage loans. In this context, a rate cut could potentially accelerate household loan growth.

Jang Yong-seong, Member of the Monetary Policy Committee, Bank of Korea

Concerns Over Increased Financial Vulnerability Due to Rate Cuts

The Bank of Korea also raised the possibility of accumulating financial imbalances due to interest rate cuts. Since 2010, during two periods of base rate cuts, the Financial Vulnerability Index (FVI), which indicates the degree of financial imbalance accumulation, has risen.

During the first rate cut period from the second quarter of 2012 to the third quarter of 2017, private credit increased mainly through household loans, and the leverage of financial institutions rose, reducing resilience and causing the FVI to increase from 17.4 to 27.6.

In the second period from the second quarter of 2019 to the second quarter of 2021, following the pandemic, asset prices surged significantly, especially in the real estate and stock markets, pushing the FVI from 33.5 to 56.2. At that time, housing prices had a major impact on the FVI increase, raising concerns similar to the current situation. The FVI for the second quarter was 31.5, slightly up from 30 in the previous quarter. Since 2008, the long-term average of the FVI is 35.3, and higher values indicate increased financial vulnerability.

The report explained that scenario analysis considering expectations of rate cuts and macroprudential policy management showed that the FVI tends to rise under eased financial conditions, but the increase slows and the effect gradually expands with a time lag as macroprudential policies are strengthened. Accordingly, it emphasized the need for appropriate macroprudential policy operation.

Jang Yong-seong, a member of the Bank of Korea’s Monetary Policy Committee, stated, "We expect the effects of major measures such as the housing supply plan and household debt management plan announced by the government last month to gradually appear," but added, "As expectations for eased financial conditions rise due to rate cuts in major countries like the U.S., it is necessary to continuously coordinate macroprudential policies along with monitoring the effectiveness of government measures." He suggested referring to policy operation cases in major countries like Canada, which have strengthened macroprudential policies alongside policy rate cuts.

The report also argued that the already announced housing supply and household debt management policies should be consistently implemented as planned, with particular emphasis on stabilizing the Stress Debt Service Ratio (DSR). The Stress DSR is a system that reduces loan limits by adding a margin rate to consider the possibility that borrowers with variable-rate loans may suddenly face increased principal and interest repayment burdens due to rising interest rates.

Additionally, the report stressed the need to prepare additional measures in advance to respond immediately depending on the housing market and household debt situation, and to further strengthen policy coordination to maintain market confidence in real estate price stability and the government’s efforts to lower and stabilize the household debt ratio.