South Korean banks are facing a significant challenge as delinquency rates on loans continue to rise. The delinquency rate on won-denominated loans reached 0.53% by the end of August, marking the second consecutive monthly increase, according to the Financial Supervisory Service last week.

This trend, especially pronounced in corporate loans, presents risks to the banking sector. Although the recent rate cut by the Bank of Korea (BOK) offered some relief by lowering bowering costs, it also introduces risks by encouraging borrowing amid already high debt levels.

RISING DELINQUENCY RATES

As of August, the overall delinquency rate on South Korean bank loans increased by 0.06 percentage points from the previous month and by 0.10 percentage points on-year. This remains below the historical average, but the trend raises concerns about financial stability.

Corporate loan delinquency rose to 0.62%, up from 0.53% in July, with small and medium-sized enterprises (SMEs) being the primary contributors. SMEs in manufacturing and construction have been particularly affected by weaker demand and rising input costs, contributing to the increase in corporate loan delinquency.

In contrast, larger corporations have been less impacted, with delinquency rates holding steady at 0.05%.

Household loan delinquency has also increased modestly. The delinquency rate for household loans rose to 0.4% in August, up from 0.38% in July.

The housing market, where mortgage loans represent a significant portion of household debt, remains a key concern. Although interest rates were high for much of 2024, the recent reduction may not be enough to prevent further delinquency, particularly if domestic consumption remains weak.

Bank of Korea, July 26, 2024 | Image: Korea Pro

INTEREST RATE CUTS

The BOK’s decision to cut its benchmark interest rate by 25 basis points aimed to stimulate a stagnant domestic economy, bringing the base rate down to 3.25%. This marked the first reduction since 2021 and is expected to lower borrowing costs for both corporations and households.

For SMEs, which have been under financial pressure, the rate cut offers immediate relief by reducing interest payments. For households, the lower rates may ease mortgage payment burdens.

However, while the cut provides short-term financial relief, it also encourages more borrowing, particularly in the housing market, where demand for loans could increase. This raises the risk of a further buildup in household debt, potentially increasing delinquency if economic conditions worsen.

BANKS’ FINANCIAL STABILITY

Rising delinquency rates pose significant risks to South Korean banks, particularly regarding loan loss provisions and non-performing loans (NPLs). The Financial Supervisory Service (FSS) reported that newly delinquent loans reached approximately $2.2 billion (3 trillion won) in August, while the resolution of delinquent loans dropped to $1.02 billion (1.4 trillion won).

This suggests banks may face an increase in NPLs, which could strain their balance sheets.

While the FSS report notes that current delinquency rates remain below pre-pandemic levels, the upward trend raises concerns about long-term financial health. Banks have been actively managing NPLs through restructuring and sales of delinquent loans, but a prolonged economic slowdown could further erode asset quality, especially among banks heavily exposed to SMEs.

As SME delinquency rates rise, banks with substantial exposure may need to increase their capital buffers, which could strain profitability and limit their capacity to extend new loans.

South Korea’s Hana Bank | Image: Korea Pro (July 2, 2024)

HOUSING MARKET RISKS

South Korean banks are heavily exposed to mortgage loans, and while the delinquency rate for housing loans is relatively low at 0.26%, there are signs that the situation could deteriorate.

Despite efforts by major banks to curb household debt through interest rate hikes in the first half of the year, demand for housing loans has remained strong. This is partly due to expectations of rising property values, which have driven speculative investments in real estate.

Lower interest rates could once again boost borrowing for housing, raising concerns about the formation of a property bubble. If external shocks, such as geopolitical tensions or rising global oil prices, impact the economy, there could be a spike in mortgage delinquency.

This would have a direct impact on banks’ balance sheets and further exacerbate financial stability concerns.

In response, the FSS has taken steps to address the rising delinquency rates by urging banks to strengthen their risk management practices, particularly in managing SME loans and household debt. Banks have been directed to maintain higher capital buffers and to take proactive measures in restructuring delinquent loans to minimize losses.

LOOKING AHEAD

The rising delinquency rates present immediate and long-term risks for South Korean banks. In the short term, the BOK’s rate cuts may offer some relief to borrowers, particularly SMEs and households, by reducing their debt servicing costs. However, the long-term risks associated with rising debt levels and increased exposure to the housing market cannot be ignored.

Banks may need to brace for a continued rise in delinquency rates, especially if the economic recovery remains sluggish. SMEs, in particular, will remain vulnerable to further economic shocks, and the housing market could experience increased volatility if demand for mortgage loans surges.

In the coming months, South Korean banks will likely face pressure to strengthen their risk management practices while navigating a challenging economic landscape.

The central bank and financial regulators will continue to monitor the situation closely, but the outlook remains uncertain. With rising delinquency rates and persistent risks in the housing market, South Korea’s banking sector is likely to encounter heightened challenges in maintaining financial stability.

Edited by Alannah Hill