Bank of Korea: Financial system stable, but housing prices and debt-fueled investment pose risks

South Korea's financial system remains largely stable, but potential risks are emerging from resurgent housing price growth in Seoul and other metropolitan areas, coupled with increased debt-financed asset investments, the Bank of Korea (BOK) reported on June 24. The central bank's "First Half Financial Stability Report" highlighted that while the overall system is sound, these factors warrant attention.

The Financial Instability Index (FSI), which measures short-term stability across various sectors, has risen compared to the previous year. This increase is attributed to continued selling by foreign investors in the domestic stock market and a rise in household debt, particularly linked to property price increases. The FSI stood at 17.2 in May, a decrease from March and April but higher than December's 16.3. The index is evaluated on a scale where below 12 is 'normal,' 12-24 is 'caution,' and above 24 is 'crisis,' with 100 representing the January 1998 foreign exchange crisis.

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Domestic financial and foreign exchange markets have seen significantly increased volatility, while housing prices in the Seoul metropolitan area are rising again, and asset investment using leverage (debt) is increasing.

While the household debt-to-disposable income ratio has seen a slight decrease, the BOK noted an increase in the proportion of vulnerable borrowers. As of the end of the first quarter, this group, defined as those with loans from three or more financial institutions, income in the bottom 30%, or a credit score below 664, constituted 6.7% of borrowers, up from 6.4% in the third quarter of last year.

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The average delinquency rate for borrowers with three or more homes was 1.35%, slightly higher than for one-home owners (0.70%).

The central bank also pointed to a rising default rate among corporations, particularly in vulnerable sectors like construction, real estate, and wholesale/retail trade. Non-performing loans in domestic banks have grown to 17.7 trillion won ($12.7 billion) as of March, up from a low of 9.7 trillion won in September 2022. Unlike previous periods where large corporations drove defaults, the current trend shows an increase primarily among small and medium-sized enterprises.

Furthermore, the report highlighted that households with three or more properties are showing a decline in their ability to repay debt. The average delinquency rate for borrowers with three or more homes was 1.35% at the end of the first quarter, significantly higher than for those with one home (0.70%) or two homes (0.52%). This trend is particularly concerning for low-income households with multiple properties, where the debt service ratio exceeds 70% of their income.

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We need to increase the base rate at an appropriate time considering inflation pressure, economic trends, and financial stability risks.