Central bank warns of household debt’s impact

The nation’s rising household debt will put a damper on the nation’s economy by curbing consumer spending in the short run while weakening the nation’s growth potential in the longer term, according to the Bank of Korea.

In its financial stability report, the KOK said in the first half of the year household debt only inched up 1.1 percent compared to the same period last year thanks to the financial regulator’s pressure on the finance industry to be conservative in their lending.

This is the slowest growth since the nation suffered through a credit card default crisis in 2003.

But total household debt was still a record 922 trillion won ($830 billion).

The central bank’s report noted that although growth in household borrowing has slowed, risks of bad debt impacting the economy as a whole had grown sharply, especially with a generally slowing economy and persistently weak property market.

Korea is facing risks of mortgage crisis similar to the subprime economic meltdown in the U.S. in 2008 and after.

In a July survey of 74 financial experts, 89.2 percent said household debt was one of the top five risks that could hurt the nation’s financial system. This was a sharp increase from 67.6 percent in a survey six months earlier. Household debt was the second largest risk after the euro zone fiscal crisis.

In financial conditions of vulnerable parts of society, like retirees starting their own businesses or low income families, is getting worse with their debts increasing.

“Although the household debt overdue rate is relatively low, overdue payments particularly from small entrepreneurs and low-income borrowers are growing,” the report said.

While total household debt including credit card spending is at a record level, an underlying problem is that the debt-to-disposable-income ratio is rising. The ratio in the first half of this year was 134 percent, far higher than the 122 percent in 2007 prior to the global financial crisis that occurred the following year.

Borrowing by small restaurant or lodging businesses, which are highly sensitive to economic conditions, amounted to 430 trillion won as of last March, a nearly 17 percent increase compared to a year earlier.

“The reason small entrepreneurs’ debts increased so sharply is because of the struggling domestic market, which has cut their incomes,” said a BOK official. “These are loans that are used not only for managing their businesses but also for spending on daily necessities.”

Such loans are expected to increase further as many baby boomers are expected to retire later this year and try to start up new businesses.

Borrowers with low credit ratings accounted for 58.1 percent of fresh loans from private lenders, which charge higher interest rates than commercial banks or other nonbanking financial companies like insurance firms. On existing loans, private lenders accounted for more than 85 percent.

As debt pressure mounts, consumer spending has already slowed. In the first half of the year, consumer spending increased 2.5 percent, a significant deceleration from the 6.1 percent posted in 2011 and the 7.1 percent in 2010. Consumer spending was nearly the same as in 2009 when shoppers tightened their purses in the aftermath of the global crisis.

“It is essential to expand a system in which the debtors can repay debts in installments,” a BOK official said. “Additionally new jobs need to be created so that debtors that are more vulnerable to a default due to weakening income could see greater job opportunities.”

By Lee Ho-jeong [ojlee82@joongang.co.kr]