[Financial Microscope] The Radical Lee Jaemyung-Style Bad Bank... A Look at Previous Administrations

From Hanmaeum Finance in 2004 to the Saechulbal Fund in 2023
Personal Debt Adjustment Programs... A New Face with Every Administration Change
Consistently Expanding Debt Relief Rates... This Time, Complete Debt Cancellation
Broader Coverage Than Moon Administration's 'Long-term Delinquent Debt Relief'
Ongoing Debates Over Funding Beyond Supplementary Budgets and Moral Hazard

The Lee Jaemyung administration's debt adjustment program (bad bank) for long-term delinquent borrowers is set to be implemented later this year. The program targets individuals who have been unable to repay loans of 50 million won or less for over seven years. The government has announced plans to either write off the debt entirely or reduce the principal by up to 80%, depending on the debtor's repayment ability. The "personal debt relief" policy began under the Roh Moo-hyun administration and has continued under subsequent administrations, each time under a different name. However, there is a growing perception that this latest program is more radical than those of previous governments. What are the reasons for this assessment?

Debt Relief Rates Expanding with Each Administration Change... More Beneficiaries Than Under the Moon Administration

Successive administrations have operated personal debt adjustment programs, or bad banks, at the start of their terms, despite criticism that such measures encourage moral hazard. The rationale has been to help those trapped in long-term delinquency recover and to boost economic growth by restoring their spending power. Each time the economy faced a crisis severe enough to cause instability, bailout-style support was deemed necessary. The first specialized bad bank for individual debtors in Korea, Hanmaeum Finance, was established during the Roh Moo-hyun administration in response to a surge in personal credit delinquencies following the 2003 credit card crisis. The Credit Recovery Fund under the Lee Myung-bak administration was also established as the issue of illegal private lending became prominent during the global financial crisis.

The current administration is promoting a bad bank due to the ongoing challenges faced by borrowers amid the COVID-19 pandemic and prolonged low growth. According to the financial sector, as of the end of March, loans to small business owners and SMEs set to mature in September total approximately 47 trillion won. The government estimates there are about 1.13 million long-term delinquent borrowers. In response, the government is expanding and reorganizing the Saechulbal Fund, a bad bank specialized for small business owners, and is also creating a separate bad bank for small-scale long-term delinquent borrowers to help alleviate their debt burden.

The principal reduction rate is higher than under previous administrations. Hanmaeum Finance, established in 2004, and its successor Himangmoa, only reduced the principal by about 30% for lump-sum repayments, effectively offering no principal reduction. Principal reduction policies began in earnest with the Credit Recovery Fund in 2008. The reduction rate has continued to increase with each administration: the Credit Recovery Fund offered up to 50%, the expanded National Happiness Fund up to 70%, and the Saechulbal Fund, though with some differences in eligibility, offers up to 90% principal reduction.

Under the current administration's bad bank, if a debtor is deemed unable to repay, their entire debt will be written off. This approach is similar to the long-term delinquent borrower rehabilitation policy of the Moon Jae-in administration. However, the scope of beneficiaries is much broader this time. While the Moon administration targeted those with debts of 10 million won or less and delinquency periods of up to 10 years, the current administration's program covers debts five times larger and shortens the delinquency period by three years.

Half of the Funding to Come from Banks... Concerns Over Repeated 'Debt Relief' and Moral Hazard

The current administration's bad bank will operate by purchasing non-performing loans, similar to the Credit Recovery Fund in 2008. The estimated amount for these purchases is 800 billion won. Of this, 400 billion won will come from the second supplementary budget, with the remainder to be covered by banks.

Banks contributed funds during the Credit Recovery Fund era as well, but their burden is greater this time. Previously, banks supported the fund mainly by forgoing money they were owed. When the Credit Recovery Fund was created, banks contributed about 1 trillion won, which came from the surplus of the Non-performing Loan Resolution Fund. This fund was established after the 1997 financial crisis to resolve bad loans, and banks had contributed some of the capital. As non-performing loans were recovered, surplus funds accumulated, but instead of returning this money to the banks, the government used it as the financial base for the Credit Recovery Fund.

However, this time there are no remaining surplus funds, so banks must provide the money directly. This creates an ironic situation where banks lend money and then pay additional funds to repay debts on behalf of borrowers. The banking sector acknowledges the intent of the policy but remains cautious. One bank official commented, "While the amount is not insignificant, sharing the burden means it is not large enough to threaten banks' financial health. Since this policy was not unexpected, it is hard to call it a risk." However, the official also expressed concern, saying, "If people believe the government will pay off their debts even if they default, this could lead to moral hazard, making it harder to manage delinquencies in the future."