‘Rapid increase in household debt may trigger gov’t fiscal crisis’
Concerns are mounting that the rapid increase in household debt could escalate into a financial crisis, as a sudden fall in the values of homes and stocks could put many overleveraged borrowers into default, experts warned Sunday.
They said the Korean economy could fall into a vicious cycle whereby the financial status of lenders becomes compromised and worsens rapidly due to reduced fiscal headroom brought on by fast-growing government debt amid the COVID-19 pandemic.
If debtors are unable to repay their loans following a sharp drop in the value of assets ― notably homes ― commercial banks will see their financial health deteriorate precipitously, prompting the government to intervene to prevent a chain reaction of defaults at financial institutions.
However, a large number of defaults following steeper-than-expected asset price falls could overwhelm the government’s fiscal tools, limiting the effectiveness of its crisis management capabilities and the economy will suffer as a result.
“Household debt is only as significant as where the borrowed money was spent,” Seoul National University economics professor Lee In-ho said.
Government and household debt should be treated separately, according to Lee, because unlike the former, which represents the fiscal health of a country, the latter is a matter concerning individual finances, defined by people’s ability to repay loans.
There is no problem if a borrower is able to pay their monthly installments, with the value of the asset purchased continuing to rise. But the latest developments in the financial markets suggest otherwise.
Many young Koreans bought homes with borrowed money during the Moon Jae-in administration, pushing up apartment price indices here to record highs over the past few years. But the shock will materialize once a few defaults trigger price adjustments, Lee said. The peak will then be followed by a nosedive, since more people will dump their once-overvalued assets to avoid bankruptcy.
“In that very probable scenario, banks will not be able to retrieve loans, with pressure increasing to set aside greater loss reserves. Their business will take a dive, requiring the help of a government that may not have much room to maneuver,” Lee said.
BOK Governor Lee Ju-yeol also warned Friday against a steep rise in leveraged household borrowing to invest in stocks.
“Investors may have to endure an intolerable level of loss when a (share) price is adjusted at a time when the stock market index has recently been rising rapidly,” Lee told reporters in an online press conference.
“When the index grows too fast, there is ample chance for the stock price to be readjusted due to external unpredictability ― such as any changes in major economies’ monetary policies, geopolitical risk factors and possible supply disruptions of COVID-19 vaccines,” he said.
The series of grim predictions is gaining traction, as illustrated by Bank of Korea data showing outstanding household loans from commercial banks standing at 988.8 trillion won ($898 billion) in 2020, up 100.5 trillion won from a year earlier. This is an explosive increase from annual increases of 60 trillion won seen in the previous two years.
Of them, mortgages jumped by 68.3 trillion won, while lending statistically categorized as “other loans” ― mostly credit (non-secured) loans ― increased by 32.4 trillion won.
Data from the Institute of International Finance showed Korea’s household debt-to-GDP ratio standing at 100.6 percent in the third quarter of 2020, surpassing the 100 percent mark for the first time. This contrasts with figures for the U.S. (81.2 percent) and advanced countries which average 78 percent.
“The pace of the increase should be monitored as well as where the borrowed funds are flowing into,” professor Lee said.
Governor Lee said that the central bank will keep a close watch on risks associated with the soaring household debt.
“The rapid increase of household debt is somewhat inevitable due to the pandemic, a problem that cannot be solved in a short period of time. Continued monitoring is required along with macroprudential measures by the financial authorities. We will discuss ways to manage household debt with related risks factored in,” he said.