Bloomberg News

Korea to Promote Fixed-Rate Loans to Control Household Debt

June 29, 2011

(Updates with analyst comment in fourth paragraph.)

June 29 (Bloomberg) -- South Korea said it will encourage banks to cut lending in floating rate loans as record household debt and rising interest charges increase risks to the economy.

Banks will be asked to lift the ratio of fixed-rate loans to 30 percent from the current 5 percent by 2016, Lee Suk Joon, a commissioner at the nation’s financial regulator, told reporters today in Seoul. Lenders should also offer fewer borrowers grace periods on repayments, the Financial Services Commission said in a statement.

Floating-rate mortgages account for 95 percent of home loans in South Korea, compared with 10 percent in the U.S. and 62 percent in the U.K., according to the statement, citing figures for 2009. That leaves the nation’s households, with a record 801.4 trillion won ($740 billion) in debt, exposed to higher repayments as the central bank raises borrowing costs.

“An increase in fixed-rate loans will reduce default risks when interest rates are rising, which is good for banks in the long run,” Ku Yong Uk, a banking sector analyst at Daewoo Securities Co. in Seoul, said. “The measures will help keep the household debt from becoming a real threat to the financial system as well as the economy.”

About 40 percent of South Korean mortgage loans, or 117 trillion won, require the borrowers to repay all of the principal in one payment at the end of a set period, compared with 9.7 percent in the U.S. and 7.5 percent in Europe, according to the regulator.

Above OECD Average

The ratio of household liabilities to disposable income was 153 percent in 2009 in South Korea, above the 134 percent average for member economies of the Organization for Economic Cooperation and Development, the FSC said.

“What concerns us is the fast loan growth and vulnerable loan structure,” said the FSC’s Lee. “Today’s measures are intended to slow down the growth and make the loans less risky to the economy,” he said, adding that debt levels are “manageable” now.

Non-bank financial companies, including credit card issuers, need to set aside more provisions for bad loans, the FSC said. The government will provide tax incentives for borrowers to switch to fixed-rate mortgages and to repay principal in installments, according to the statement.

Bank of Korea board member Kang Myung Hun said on June 16 that a comprehensive response was needed to avoid causing a crisis as the nation tackled the debt problem.

Rate Increases

The Bank of Korea’s policy board raised the benchmark interest rate to 3.25 percent on June 10 in a unanimous vote, citing risks of inflation and household debt. The bank began increasing borrowing costs from a record-low 2 percent last July.

“A sharp increase in interest rates may burst the household-debt problem,” Kang said. “If the debt-bomb blows, builders and lenders will be crippled and property market will crash when people start to sell off their homes to repay debt.”

Fitch Ratings warned in April that it may cut China’s local-currency credit rating on concern that increasing corporate and household debt is a risk to government finances.

Rising household debt in the Nordic countries may pose a threat to financial stability and economic developments, Standard & Poor’s said on May 30, giving backing to policy makers seeking to toughen capital standards.

Erik Lueth, a Hong Kong-based economist at Royal Bank of Scotland Group Plc., said last month that Korean households face powerful incentives to increase their debt and hence interest rates must rise toward or even beyond the economic growth rate.

Separately, the nation’s financial regulator released guidelines encouraging banks with a capital adequacy ratio of at least 10 percent to sell covered bonds, according to an e-mailed statement today. Covered bonds are backed by assets such as mortgages that can be sold in case of default.

--With assistance from Bomi Lim in Seoul. Editors: Ken McCallum, Brett Miller

To contact the reporter on this story: Eunkyung Seo in Seoul at eseo3@bloomberg.net; Seonjin Cha in Seoul at scha2@bloomberg.net

To contact the editor responsible for this story: Paul Panckhurst at ppanckhurst@bloomberg.net


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