Central bank warns of worsening financial stability

By Lee Kyung-min

Korea's financial stability has deteriorated over the past few months due to a mixture of domestic and global negative developments, the central bank said Thursday.

The Bank of Korea (BOK) issued a quarterly report on the financial stability measured by 20 indices including debt amount and their subsequent default risks, derivative products-related risks and exchange rate fluctuations.

Chief among the negatives are heightened volatility in the foreign exchange market triggered and prolonged by the drawn-out U.S.-China trade feud, further compounded by falling corporate margins, an inevitable consequences of the export-reliant economy.

The Financial Stability Index, an overall measure of the financial market risk, stood at 8.3 in August, surpassing the 8-point mark for the first time since early 2016.

On a scale of zero to 100, readings moving within a range of eight and 22 means the country is advised to take caution to avoid a possible financial crisis, while readings over 22 means the country has entered one.

Since 1996, out of eight instances whereby the index surpassed the 8-point mark, three had developed into a full-fledged crisis.

The index was 100 in January 1998 following the Asian financial crisis, 24.8 in January 2001 amid fallout from the dot-com bubble in the U.S. and 57 in December 2008 following the global financial crisis.

“The index surpassing the 8-point came amid weak consumer sentiment dampened by U.S.-China and Korea-Japan trade disputes and external uncertainties gripping holders and investors of financial assets,” a BOK official said at the press briefing.

“More focus should be put on the gradual increase of the index since March, rather than it having breached the 8-point mark,” he added.

The report said of 22,869 firms subject to outside audit, 3,236, or 14.2 percent, saw their interest rate coverage ratio fall below 1 in 2018.

Particularly risk-prone industries were eateries, 35.8 percent of which saw the ratio fall below 1, followed by shipbuilding (24 percent), real-estate rent business (22.9 percent), logistics (18.7 percent) and maritime transport (16.8 percent).

The ratio, used to assess the risk of lending to a firm, is calculated by dividing a company's earnings before interest and taxes by the company's interest expenses for the same period.

It is used to see how well a firm can pay the interest on an outstanding debt. A ratio of below 1 means a company's operating profit was too small to even meet the interest payments.

Loans made out to the firms with below 1 was 107.9 trillion won ($89.2 billion) in 2018, up 7.8 trillion won from the year before.

“Particular monitoring is required in the sector because they can lead to outright delinquency and default, which in turn could develop into a full-blown crisis of the lenders. Given the recent harsh business environment greater attention should be paid to better manage credit risk of such firms,” the BOK said.

Household debt grew faster than income, mostly from non-Seoul residents that took out loans from high-risk, low-tier lenders, raising alarms about financial management.

The loan-to-income (LTI) ratio for household loans taken out by non-Seoul residents stood at 207.7 percent as of June 2019, up 55.5 percentage points from 2012, when the ratio was 152.2 percent.

This was a faster rise than the LTI for those taken out by people living in Seoul and surrounding Gyeonggi provincial areas whose ratio was 232.4 percent, up 40.1 percentage points from 2012.

“When it comes to risk management of household debt in rural areas, the financial authorities should consider that the residents there are more prone to default risks compared to Seoul residents given they differ in their ability to repay debt,” the BOK said.

Regarding risks associated with derivatives-linked financial products the central bank said that American or European lenders with high derivative products trading volumes could cause substantial disruption to the local derivatives market.

“We judge that the country's financial resilience is at a healthy level. But continued, closer monitoring is required to properly act to limit chain reactions in the closely linked value chains in the country's economy in the event of an unfortunate scenario,” it added.