Household Debt Management

Household Debt Management Key Strategies


Background


The size of household debt in Korea has been expanding as the economy continued to grow in the aftermath of the Asian financial crisis of 1997. Over the years, the quantitative growth has been accompanied by a qualitative improvement in the structure of household debt due to increases in the proportion of fixed rate lending and installment payments. For instance, between 2013 and 2019, the proportion of fixed-rate lending and installment payments rose from about 15.9 percent to 49.4 percent and 18.7 percent to 52.6 percent, respectively. The overall soundness of household debt has been stable as the total volume of financial assets held by households surpassed that of financial debt by more than twice (2.15 times at the end of 2009 and 2.16 times at the end of Q2 2020) and the delinquency rate across all financial sectors dropped from 1.74 percent (end-2009) to 0.70 percent (end-June 2020).


<Household Credits>

(%, y-o-y, Bank of Korea)

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Q4
2015
Q4
2016
Q4
2017
Q4
2018
Q3
2019
Q4
2019
Q1
2020
Q2
2020
Q3
2020
Q4
2020

Household credits

10.9

11.6

8.1

5.9

3.9

4.1

4.6

5.2

7.0

7.9


Household loans

11.0

11.6

7.9

5.6

3.8

4.0

4.8

5.3

7.0

8.3



Mortgage loans

14.0

12.1

7.6

4.9

4.3

4.3

5.7

6.4

7.2

8.0


Others

7.5

10.9

8.3

6.5

3.1

3.6

3.8

4.0

6.8

8.4

Between 2016 and 2019, the government’s consistent efforts to manage the pace of household debt growth led to a gradual drop in the household credit expansion from 11.6 percent to 4.1 percent. However, this downward trend reversed its course in 2020 as the government began to implement expansionary fiscal and monetary policies in response to the COVID-19 pandemic. In particular, the household debt growth in 2020 was accelerated by a spike in the volume of credit-based loans as more and more individuals borrowed to invest in financial products amid a prolonged low interest rate environment. The rise in housing transactions as well as the increase in jeonse (a lump sum deposit for rent without monthly payment) prices also contributed to the surge in household debt in 2020. Toward the end of 2020, the growth in credit loans and personal mortgages that led the rise in total debt levels appeared to have stabilized. However, loans for rent deposits, collective lending extended to new apartment buyers and government-sponsored home mortgages all continued to climb back up with the nonbank sector also experiencing a demand surge for loans.

In recent months, the household debt to GDP ratio as well as the pace of its growth has been identified as the greatest potential risk to the economy. In this regard, the authorities have been considering the following three factors in drawing up appropriate measures to control household debt. First, the household debt to GDP ratio in 2020 has grown to more than 100 percent. This may hold back formation of aggregate demand and potentially harm macroprudential soundness when asset prices go into an adjustment. Second, the household debt to GDP ratio in Korea has been growing more rapidly in comparison to other developed countries. This pace of growth may lead to a further deepening of financial imbalances in Korea. Third, considering that eventual interest rate hikes take place in the future, the burden of repayment can be overwhelming for borrowers and especially on vulnerable debtors who have taken out multiple loans.

Although household debt stands at a manageable level at present, the need for early action has been growing in order to preempt financial risks associated with asset price hikes. Against this backdrop, the FSC has introduced a series of measures to more effectively control the growth of household debt levels.

Key Measures


I. PROMOTE LENDING BASED ON REPAYMENT CAPABILITIES
On April 29, 2021, the government introduced the household debt management plan for 2021-2023, with the goal of (a) stably managing the pace of household debt growth in the medium to long term and (b) promoting lending based on borrower’s repayment capability. In that plan, the authorities introduced a new rule on debt service ratio (DSR: calculated as a percentage of the total principal and interest payment over income) that will gradually expand the application of DSR to individual borrowers with a possibility of discontinuing the DSR application on financial institutions in three phases starting from July 2021 with the goal of completing the transition by July 2023. The authorities excluded jeonse loans, savings- and insurance-secured loans as well as government-backed microloans and other lending support initiated through government policies from calculation of DSRs on individual borrowers.

To help enhance the effectiveness of the DSR rules, the government announced a set of supplemental measures aimed at strengthening the management of household debt growth on October 26, 2021, which included a plan to move up the implementation schedule of individual borrower-level DRS by six months as shown in the highlighted texts in the table below.


<Plan for Gradual Expansion of DSR Rules on Individual Borrowers>

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Before July 2021 1st phase
(Currently in place)
2nd phase
(Implementation schedule moved up from July 2022 to January 2022)
3rd phase
(Implementation schedule moved up from July 2023 to July 2022)
Home mortgages Houses in ‘speculative’ or ‘overheated speculative’ areas with property value of KRW900 mil. or more (a) Houses priced over KRW600 million in all regulated areas - Total borrowed amount over KRW200 million

- Maintain rules
(a)+(b)
- Total borrowed amount over KRW100 million

- Discontinue rules
(a)+(b)
Credit loans Annual income exceeding KRW80 mil. & KRW100 mil. (b) Over KRW100 million
Application 8.8% of newly issued home mortgages 12.4% of newly issued home mortgages 13.2% of all borrowers 51.8% of all loans 29.8% of all borrowers 77.2% of all loans

Another important measure introduced as part of the supplemental step aims to strengthen the DSR rules in the nonbank sector. The individual borrower-level DSR applied in the nonbank sector will be lowered from 60 percent to 50 percent from January 2022 with the average institution-level DSRs also being adjusted to tighten lending control in certain sectors which exhibited high levels of growth in lending.

<Application of Adjusted Average DSR Rules in Nonbank Sectors>

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Average DSR Bank Insurance Mutual
Finance
Credit card Capital Savings
bank
Current DSR rule 40% 70% 160% 60% 90% 90%
Current DSR level 38.3% 51.9% 124.6% 55.7% 70.5% 71.5%
Adjusted DSR rule 40% 50% 110% 50% 65% 65%

In addition, a stricter standard for DSR calculation will go into effect from January 2022. The current application of maximum loan maturity when calculating individual DSRs will be replaced with the application of average loan maturity, which will help reflect more realistic standards. In addition, credit card loans issued by specialized credit finance businesses, which have not been included in the DSR calculation so far, will be counted toward a borrower’s DSR starting from January 2022. The specialized credit finance sector will also draw up a guideline to more effectively control delinquency and excessive borrowing by delinquent debtors.
II. IMPROVE QUALITATIVE SOUNDNESS OF DEBT STRUCTURE
The proportion of installment payments on home mortgage loans in Korea stands lower in comparison to other major economies. From January 2022, the authorities will begin to apply the revised up targets for home mortgage installment payments, provide incentives to financial institutions for promoting more installment payments on jeonse loans, while continuing to encourage installment payments on credit loans. More specifically, financial institutions will be given incentives to increase the volume of installment payments on jeonse loans issued to their customers. Lenders with outstanding records will be given priority when allocating government-sponsored mortgage products. To encourage more use of installment payments on credit loans, the real maturity on credit loans will be used for calculating borrowers’ DSRs when debt is being paid back in installment.
III. ENSURE CONTINUED SUPPLY OF CREDIT TO INDIVIDUALS IN NEED
As the authorities urged financial institutions to more strictly control their new loan issuance in the second half of 2021, there have been growing concerns about the problem of a credit shortage for renters as well as prospective homeowners (new apartment buyers) who need to make balance payments in the fourth quarter of this year before moving into their new homes. In this regard, the financial authorities held a meeting with major lenders and agreed on ways to alleviate these concerns for jeonse renters and prospective homeowners. The authorities decided that new household loans issued for paying jeonse deposits in the fourth quarter of 2021 will not be counted toward the government’s total volume of household debt management target. Lenders will ensure the availability of loans for prospective homeowners who need to make balance payments in the fourth quarter of 2021 while strengthening their review process to make sure that the newly issued loans to prospective homeowners are not in excess of the amount they actually need. In order to ensure a continuing supply of credit to these individuals, the authorities and lenders have set up a taskforce to closely share relevant information and review situations regularly.
IV. ENCOURAGE FINANCIAL INSTITUTIONS TO ACTIVELY MANAGE RISKS ON THEIR OWN
From November 2021, lending institutions will be subject to a stronger internal control measure for managing household credit issuance. At the beginning of every year, financial institutions submit to the authority their own plans for household loan issuance. Prior to submitting their loan issuance plans, financial institutions will be required to report to CEOs and relevant boards for approval on the details of the plan and ensure that the supply projection reflects an uninterrupted and proportionate distribution throughout the year. The financial authorities will continue to conduct biannual inspections on financial institutions to check their compliance with the various home mortgage loan and other related rules.

Household Debt Management Target for 2022


The government’s household debt management target for 2022 will be to contain the growth level to 4 to 5 percent with a goal for gradual normalization back to the pre-pandemic level. In 2020, the difference (the “gap”) between the household debt growth rate (7.95%) and the nominal GDP growth rate (0.45%) reached a record high of 7.5 percentage points. The authorities plan to gradually reduce this “gap” in 2021-2022 for the purpose of scaling back the pandemic-era “gap” average to a pre-pandemic average level.

The household debt management plan is aimed at establishing a more systematic and consistent management structure and promoting more responsible lending and borrowing activities based on borrower’s repayment capability. While closely monitoring developments in the real economy, changes in asset markets and trends in financial markets, the authorities will continue to work on fine-tuning the household debt management target and seek to minimize negative impact and credit shortage for individuals with an urgent need. To ensure seamless implementation of these measures and come up with improvements in policy response, the authorities along with the industry groups plan to operate a joint taskforce on household debt management.


Last updated: Oct. 29, 2021