FSS chief vows to ensure soft landing for debt-ridden households
Among them, mounting household debt may be the biggest headache for policymakers and regulators as they are closely interrelated to all aspects of business and thus have a far reaching impact if they spin out of control.
While household income is falling amid rising inflation, consumer debt has continued on an upward spiral despite the government’s efforts to keep them in check. What is of more concern is that the debt is growing faster than assets.
As part of efforts to address the fundamental problem associated with household debt, the head of the nation’s financial watchdog is adopting a two-pronged approach.
In the short-term, it is focusing on managing the quality of the debt by ensuring a soft landing for financially-troubled households. In the long-term, it is seeking to reform the basic structure of home loans.
“Unlike the United States, borrowers just repay interest on their loans without paying off the principal during a grace period and that prevents household debt from declining. A structural shift should be necessary to solve the fundamental problem,” Financial Supervisory Service (FSS) Governor Kwon Hyouk-se said in an interview with Business Focus.
His understanding of household debt is that the level is manageable but it runs a high risk of turning sour due to the repayment structure. He points out that the root problem is that most household debt are so-called balloon loans.
Balloon loans involve paying only the interest on the loan each month. In many cases, this is a recipe for disaster as the amount of money that people pay in interest over the term will often be as much as the amount of money borrowed. They spend months paying the interest, and then at the end of the term, they still have to pay off the entire amount that was borrowed.
“Our household debt scheme is not amortization based. That’s why the amount of debt is not decreasing. The debt level will turn downward when we have a structure that allows borrowers to amortize their loans through the life of those loans,” he said.
The 55-year-old Daegu native also said that the authorities plan to encourage local financial firms to extend home loans with fixed lending rates as part of its drive to reform the debt structure.
Under a fixed rate loan, the rate remains the same throughout the life of the loan. It provides protection against rising interest rates because the rate is set for the life of the loan. This means that the principal and interest will always be the same each month.
In line with his remarks, the government stepped in to help curb soaring household debt in late June, unveiling plans to assist households in repaying their loans and suppress irresponsible lending by banks.
The plans include promoting fixed-interest rates for home-backed loans, which mostly carry floating rates, and establishing new guidance for banks on their lending criteria.
Currently, fixed rate mortgages account for only 5 percent of total loans, but the financial watchdog plans to push up the rate to 30 percent by 2016, offering a variety of incentives to consumers such as larger tax deductions on interest payments.
According to the latest figures from the Bank of Korea (BOK), the household debt of the Asia’s fourth-largest economy reached 892 trillion won ($780.51 billion) as of the end of the third quarter in 2011.
To make the situation worse, the average household debt climbed 12.7 percent over the past year at the end of March this year according to Statistics Korea, while the average assets per household increased 7.5 percent.
Along with lending practices, the governor said that the government needs to come up with measures to help those who have a low credit rating and low incomes.
“The nation’s current household debt is linked to livelihood rather than property investment or investment techniques in the past,” he said.
“Soaring debts that have to do with livelihood is quite difficult to contain without controlling the primary factor. Therefore, the government is required to step in to deal with it.”
According to Kwon, the government needs to handle issues such as growing private education expenses and job creation in order to rein in the growth of household debt.
“With just the financial authorities’ restrictions on lending, the household debt trouble cannot be addressed because it could deal a hard blow to the economy,” he said.
Savings bank fiasco
When the former FSC Vice Chairman took office at the FSS in March, the financial sector was hit hard by the savings bank trouble that has been left untouched for about 10 years.
The nation’s savings bank industry is suffering from soured project financing (PF) loans amid the slumping property market; and due to deteriorating asset quality, a total of eight savings banks including the sector’s giant Busan Savings Bank were ordered to stop operations in the first two months of the year.
The FSS carried out a full-scale stress test of 85 savings banks, focusing principally on their debt condition and capital adequacy ratios from July and August. Seven more secondary lenders were suspended in September.
“Although the savings bank problem has not been rooted out, we could not get the full grasp of each lender’s trouble through the stress test,” said the governor, who said that until the suspension of Busan Savings Bank, the financial authorities failed to completely figure out the industry’s problem.
He said that there should be follow-ups for the ailing industry.
“We have to closely monitor if remaining savings banks do business well. The savings bank sector does not have a business model, so they have heavily relied on construction loans, which has resulted in losing their presence in microfinance to private money lenders,” Kwon said.
When the savings bank scandal swept the nation, the political circles tried to rename savings bank.
In 2002, the financial authorities permitted mutual credit unions to change their name to savings banks as part of boosting credibility, after the industry that went through a massive restructuring after the Asian currency crisis in 1997 and 1998.
Politicians insist that consumers thought savings banks were as financially sound as commercial ones due to their name.
Kwon admitted that the renaming was not appropriate.
“I agree to the claim, based on the result. However, we need to take time in mulling renaming savings banks because it can lead the savings bank industry to lose public confidence,” he said.ksw@koreatimes.co.kr
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