[Regulations Hindering Mutual Finance]② Difficult Asset Sales, Provisions Required Even for Performing Loans

Mutual Finance PF Exposure at 43.5 Trillion Won
Down 15.2 Trillion Won from End of 2023
Significant Loans Still Await Liquidation
Key Soundness Indicators Continue to Deteriorate
Performing Loans Deemed Non-viable Face Restrictions

Editor's NoteWhat are mutual finance institutions? Are they simply cooperatives that exist to benefit their members? Article 1 of the laws governing each mutual finance institution reveals their true identity. Mutual finance institutions aim to contribute to the development of local communities and the national economy, guided by the spirit of mutual aid and solidarity. This means they bear greater social responsibility than banks, whose top priorities are financial market stability and the development of the national economy. However, over the past decade, mutual finance institutions have faced criticism for prioritizing profitability over their obligations to serve ordinary citizens and local communities. The underlying causes include not only market conditions but also poorly designed government regulations. Since 2015, stricter household loan regulations have driven a surge in corporate lending, which in turn has led to real estate project financing (PF) insolvencies and deteriorating performance. In this special series, Asia Economy examines the side effects of regulations that are constraining mutual finance institutions. Through this, we aim to propose policy alternatives that will help mutual finance institutions reclaim their identity and drive innovation.

Although efforts are underway to resolve the issue of non-performing real estate project financing (PF) loans within the mutual finance sector by restructuring PF project sites, progress has been slow due to regulatory barriers. Industry insiders generally view the financial authorities’ swift actions positively, but they unanimously agree that temporary regulatory easing is necessary for faster restructuring and resolution of project sites.

According to the Financial Supervisory Service on September 11, the exposure of mutual finance institutions to real estate PF stood at 43.5 trillion won as of the first quarter of this year. This represents a decrease of 2.6 trillion won compared to December of last year, and a reduction of 15.2 trillion won from the end of 2023 (58.7 trillion won).

However, the pace of PF project site resolution remains sluggish. In the September 2024 assessment, 23.9 trillion won in loans were identified for restructuring and resolution. Nearly a year later, only 9.1 trillion won has been processed, leaving 14.8 trillion won outstanding.

Narrowing the focus to mutual finance, the sector’s financial health is not improving easily. The ratio of substandard and below PF loans soared from 5.33% at the end of 2023 to 26.7% in the first quarter of this year. By sector, industries other than mutual finance either maintained a steady ratio until a rise in March (banks, securities, credit card companies, insurance) or have seen a consistent decline (savings banks). In contrast, mutual finance institutions already showed high levels last year-16.17% in June, 21.28% in September, and 20.41% in December-but the figure has climbed even higher this year. Capital adequacy ratios are also low. Although the sector met the minimum regulatory ratios, it recorded just 7.9%, far lower than other sectors (securities 818.5%, banks 16.5%, etc.).

Performing Loans Deemed Unviable... Unable to Sell or Auction, Yet Required to Set Aside Provisions

Industry representatives acknowledge that the current business viability assessment is generally positive, but argue that certain regulations make it difficult to resolve non-performing project sites. Financial authorities have improved the business viability assessment standards to reflect the unique characteristics and risk factors of PF. Financial companies now conduct quarterly ongoing assessments of all PF project sites according to these improved standards. The business viability assessment classifies projects into four categories: Good, Normal, Caution, and At Risk of Default. Projects rated as Caution or At Risk of Default must be restructured or resolved according to post-management plans established by the financial institution. There are two ways to resolve a project site: public auction and the sale of non-performing loans (NPL).

The problem is that some projects rated as Caution or At Risk of Default are still performing loans, not loans in default. Loan default refers to cases where the borrower fails to repay principal and interest, allowing the lender to recover the full loan amount before maturity. The longer a loan remains in default, the greater the benefit of selling it rather than attempting recovery, so sales are often pursued. In other words, only when a loan is in default can it be sold as an NPL or the project site auctioned. However, for projects rated as Caution or At Risk of Default that are still performing, neither auction nor sale is possible, making resolution itself impossible, according to the mutual finance sector.

These project site loans are not classified as substandard and below, yet institutions are still required to set aside provisions. Loan assets are classified into five stages: Normal, Precautionary, Substandard, Doubtful, and Estimated Loss. Financial authorities require that even if a loan is classified as Normal or Precautionary, if it is rated as Caution or At Risk of Default in the business viability assessment, a loan loss provision must be set aside for that loan. The increased burden of loan loss provisions inevitably leads to reduced profits. Furthermore, the required loan loss provision ratio for real estate and construction loans in the mutual finance sector will be raised to 130% by the end of this year. It was already increased to 110% in June 2024 and to 120% starting in July. This issue was also raised at the confirmation hearing for Lee Okwon, the nominee for chairman of the Financial Services Commission, held on September 2. At the time, Assemblyman Kim Sanghoon from the People Power Party stated, "While there are benefits to raising the loan loss provision ratio, if it is increased too rapidly, it could make it even more difficult for farmers and small business owners to obtain loans or manage their finances." In response, nominee Lee said, "Although the risks of real estate loans have not been resolved, I will carefully consider the circumstances of the sector."

Project Site Resolution Stalled at the Fund Recovery Stage Due to Lending Regulations

There is also an opinion that even when unviable projects move to the stage of public auction or NPL sale, the final resolution is delayed due to lending regulations. After a project is auctioned and a successful bidder is selected, the bidder must actually acquire the project site. Similarly, after an NPL is sold through a mutual finance subsidiary and the project site is resold via auction, funds must be recovered for the NPL to be fully resolved. However, the final stage-fund recovery-is not being completed because real estate operators who win the bid or purchase the site at auction cannot fully acquire the project with their own capital and need to obtain a winning bid balance loan (a loan secured by the auctioned property). In reality, such loans are virtually unavailable. Since the assets themselves fall under real estate or construction, mutual finance institutions face difficulties in issuing these loans due to regulatory limits on real estate and construction lending. Currently, mutual finance institutions are restricted to lending no more than 30% of their total loans to real estate and 30% to construction, with a combined cap of 50% for both sectors. Temporary regulatory easing measures for mutual finance have been limited to "partial easing of joint lending standards for restructuring loans," while similar credit extension limit regulations for savings banks, another secondary financial sector, have not been relaxed.