A man sits at the retail lending section at the Seodaemun branch of the National Agricultural Cooperative Federation, better known as Nonghyup, in central Seoul on Sept. 1, 2011, the first day when major banks started lending to households after having suspended the service since Aug. 17. Major banks try to restrict lending to low-income earners with poor credit history. / Korea Times file

Is Korea's household debt really that bad?

By Kim Da-ye

The Korean government has boasted of how well it weathered the global financial crisis but has so far failed to dispel what has been haunting the nation for over a decade — household indebtedness.

The amount of household debt exceeded 900 trillion won ($795 billion) last year with low-income earners increasingly turning to the secondary banking sector to borrow at high interest rates.

Among the government, the media and the financial industry, household debt is considered one of the biggest risks to the Korean economy. After all, it was household debt in the U.S. that instigated the collapse of financial institutions involved with toxic mortgages and set off the global financial crisis.

The proportion of Korea’s household debt against the gross domestic product (GDP) and disposable income were high at 85.9 percent and 152.7 percent respectively as of 2009. The average figures among OECD countries were 77 percent and 134.1 percent, according to the Financial Services Commission (FSC).

The ratio of household debt to GDP was 100.2 percent in the U.S. — the country highlighted by lavish borrowings by households before the crisis — although the debt to disposable income ratio was lower than Korea’s at 132 percent.

Judging the health of an economy by the level of household debt, however, has its limits. For instance, in Scandinavian countries, household debt tends to be large because their disposable income is relatively small after heavy taxation. Scandinavian households, however, face little default risks because of the social security system built strong with taxpayers’ money.



With the nature of Korea’s household debt considered, is it really a big problem to the economy?

Tan Kim Eng, the senior director of sovereign and international public finance ratings at Standard & Poor’s, said in an interview with Business Focus that the indebtedness of the private sector including both households and businesses is indeed high.

“There is a very small number of countries with a higher debt to GDP ratio than Korea has,” Tan said.

Tan, who has a major role in deciding Korea’s sovereign credit rating, however, pointed out the differences between the characters of household debt here and in the U.S.

Firstly, Korean banks’ reliance on wholesale funding is higher than their Asian counterparts but lower than European or American ones, Tan said. Korean banks are dependent on domestic deposits, which are more stable than wholesale funding.

Furthermore, Koreans have stronger incentives to pay off their mortgages because lenders can chase after their other assets if they default on the loans while American borrowers would simply give back the keys to the banks.

Tan adds that the loan to value ratio of mortgages in Korea — the portion of the mortgage amount to the value of a property — is “a lot” lower than that in the U.S., which means that less lending risks for banks here. According to the FSC, the ratio for Korea was 47 percent as of the end of 2009, compared to 74 percent for the U.S., 61 percent for the U.K. and 80 percent for France.

While the probability of a subprime mortgage crisis taking place in Korea is “not so serious,” Tan observes the large household debt contribute to limit the central bank’s ability to freely use its monetary policy tools against inflation.

Because household debt in general is short term in nature, changes to the interest rate, the key tool of monetary policies, can have an immediate and dramatic impact on households. Tan said that the Bank of Korea raised the policy rate much slower than expected after the crisis despite the rising inflation and that he assumes it did so in order to minimize the impacts on household debt. He instead sees the government controls utilities companies from hiking prices, causing financial strain to them.

On the side of actual households, risks come from decrease in savings here in contrast to many OECD countries that save more and more.

The percentage of Korea’s net savings out of disposable income plunged from 5.2 percent in 2006 to 2.9 percent in 2007, according to OECD’s statistics. It rose to 4.6 percent, but is expected to decrease to 3.8 percent in 2012 and 4.1 percent in 2013.

Australia, which Tan mentioned as a country with a similar level of household debt to Korea, has shown a stellar growth in savings rate. It grew from 2.1 percent in 2006 to 5.5 percent in 2008 and again to 9.3 percent in 2010. The rate is expected to reach 10.5 percent in 2013.

In the U.S., after the financial crisis, households have become frugal compared to the pre-crisis era. The savings rate jumped from 2.4 percent in 2007 to 5.3 percent in 2010 although the figure is expected to drop to 4.5 percent in 2013. In Japan, the figure jumped from 2.4 percent to 6.2 percent during the same period.

Not surprisingly, Korea’s household spending increased over the time. The OECD statistics shows that it went up from $546.6 billion in 2004 to $689.9 billion in 2007 and $746.3 billion in 2010. That represents a 36.5 percent increase in six years.

Increase in spending was less dramatic in other developed countries hit hard by the financial crisis. In the U.S., household spending inched up from $9.77 trillion in 2007 to $10.25 in 2010 while that in the U.K. did from $1.39 trillion to $1.43 trillion.

Solution

Having pointed out the short-term nature of Korea’s household debt as a weakness, Tan of S&P said that local banks can make long-term, fixed rate lending to customers without taking on too much risk if there is an active domestic long-term bond market for banks to secure long-term, stable funding. From the banks’ point of view, offering a long-term loan at a fixed rate is difficult because funding comes from short-term deposits on variable interest rates.

“Interest rate and maturity mismatches aren’t good for the banks. By offering short-term loans, they are passing the risks to the customers,” Tan said.

The country’s financial authority is aware of such the problem, and declared last June that it would encourage fixed-rate mortgages carrying long-term amortization as part of the comprehensive plan to help household debt to make a soft landing. The FSC has set the goal for the portion of such the mortgage type to account for 30 percent of the total.

Oh Suk-tae, the regional head of research for Korea at Standard Chartered, provides a more pessimistic view on reducing risks stemming from household debt.

“The only solution to household debt is a financial crisis, which would force households to deleverage. Take an example of the credit card crisis in 2002 that led to deleveraging,” Oh said, adding that the soft landing that the government is planning for is a difficult scenario.

The economist said that the latest trend in household debt is increasing reliance on the secondary banking sector. In 2011, lending to household grew by 7.6 percent — slower than 8.1 percent in 2010 — but that by the secondary banking sector rose 9.9 percent as large banks closed their doors to borrowers with low credit ratings.

Oh said that the working class being forced to borrow on high interest rate loans could spark debate over welfare, which may lead to low-interest loans specially designed for them. But such the measure favorable towards the working class can again draw criticism for letting household debt keep ballooning up.

“Household debt has been an issue for over ten years. It really has no solution,” Oh said.