Corporate Debt Leverage Shows 'Red Flag'... Concerns Over Real Estate Concentration and Credit of Marginal Firms

Corporate Loan Growth Rate Nearly Doubled Before and After COVID-19
Continuous Decline in Debt Quality... Significant Increase in Debt Leverage of Real Estate Sector with Many Marginal Firms
Financial Institutions Need Qualitative Improvements to Strengthen Core 'Funds Intermediation' Function
Government Must Also Develop Industrial Policy Plans for Strategic Resource Allocation

Since the COVID-19 pandemic, corporate debt leverage ratios have risen sharply, raising concerns that the quality of accumulated corporate loans is continuously deteriorating, and that the efficiency of financial institutions' fund intermediation functions and macroprudential indicators may also worsen. There is a growing need to strengthen monitoring of vulnerable areas and for financial institutions to make efforts toward structural improvements.

According to the Financial Research Institute on the 12th, Senior Research Fellow Shin Sang-sang emphasized in a discussion titled "Efficient Allocation of Corporate Loans and Enhancement of Growth Potential" that measures are needed to restore the efficient financing function of corporate loans to contribute to expanding the economy's growth potential and to help improve macroprudential stability in the medium to long term. According to the Bank of Korea's fund circulation statistics, the outstanding balance of domestic corporate credit, which includes loans, bonds, and government financing, was estimated to be close to 2,800 trillion won as of the end of June.

The growth rate of corporate credit outstanding accelerated sharply after the pandemic. From 2010 to 2019, the average quarterly growth rate of corporate credit was 4.8%, but from 2020 to 2023, it doubled to 9.3%. In particular, the growth rate of corporate loans surged more than twofold from 5.3% before the pandemic to 10.8%. This year, large corporate loans mainly showed a high growth rate centered on banks, while small and medium-sized enterprise (SME) loans slowed down, mainly in the non-bank sector. Shin evaluated, "The quality of debt remains at a low level, with the proportion of non-bank loans, which are relatively high-interest products, accounting for about half of SME loans."

The most notable feature of the corporate debt expansion process is that the increase was faster than in other major countries and closely related to the real estate market boom. According to statistics from the Institute of International Finance (IIF), the corporate debt ratio (corporate leverage ratio) relative to nominal gross domestic product (GDP) stood at 112.3% as of June, significantly exceeding the global average of 90.6%. This is a result of a sharp increase of nearly 17 percentage points from 95.5% in 2020 to 112.3%. During the same period, the global average increased by only 1.0 percentage point.

There was also a noticeable concentration of corporate loans in certain industries. Corporate loans increased significantly in industries classified as relatively low productivity, such as real estate, wholesale and retail trade, and food and accommodation services. From the end of 2019 to the end of 2023, the corporate loan leverage ratios for real estate, wholesale and retail trade, and food and accommodation services rose from 197.0% to 308.6%, 105.9% to 165.2%, and 122.7% to 149.2%, respectively.

The scale of real estate loans in the financial sector also increased sharply by 310 trillion won from 2018 to 2023. The ratio of real estate corporate loans to nominal GDP (corporate debt leverage ratio) surged from 13.1% to 24.1%, and during the same period, the share of non-bank loans in development and leasing businesses accounted for 73.3% and 42.7%, respectively, significantly deteriorating the quality of debt.

Shin pointed out, "The increase in loans to wholesale and retail trade and food and accommodation sectors was inevitable in overcoming the economic recession caused by the pandemic," but added, "The concentration of loans in the real estate sector poses serious problems to the fundamental role of finance in efficient resource allocation." In fact, the proportion of borrowings by marginal firms within the real estate sector reaches 43.8%, and the real estate sector accounts for 26.0% of total borrowings by marginal firms.

Therefore, to prepare for the possibility of further deterioration in soundness indicators in vulnerable areas and to strengthen the fundamental fund intermediation function of finance, qualitative improvement efforts are needed not only by financial institutions but also by the government. Shin advised, "In addition to strengthening monitoring, it is necessary to continuously enhance financial institutions' loss absorption capacity in preparation for increased external uncertainties," and "Financial institutions need to make their own structural improvements in loan areas where fund allocation has proceeded disconnected from productivity." He added, "Policy authorities should also prepare resource allocation plans from an industrial policy perspective to discover high-potential innovative industries and strategically allocate resources to future core growth industries to enhance national competitiveness."

He also raised the need for prompt restructuring of marginal firms' credit risks. The increase in marginal firms in the real estate sector can generally act as a factor that raises credit risk and potential non-performing loans. Shin emphasized, "The increase in marginal firms can cause negative external effects on normal firms," and "Prompt restructuring and continuous structural reforms of vulnerable sectors considering industry-specific characteristics are necessary."