South Korea's real estate-heavy household debt risks 'slow collapse,' expert warns

South Korea's household debt, heavily skewed towards mortgages, is potentially on a trajectory toward a 'slow collapse,' according to Kim Yong-ki, head of the Production and Inclusive Finance Research Institute. Despite seemingly low delinquency rates, Kim warns that the financial system faces significant risks as rising interest rates, stagnant incomes, and potential housing price adjustments squeeze borrowers.

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The low delinquency rate is not an indicator that refutes the possibility of a 'slow collapse.'

Kim likens this potential 'slow collapse' to Japan's prolonged real estate bubble burst in the 1990s, contrasting it with the rapid implosion of the U.S. subprime mortgage crisis in 2008. He explains that a 'slow collapse' is characterized by a gradual decline in consumption and growth rates, even with low overall delinquency. Borrowers, he notes, typically exhaust various coping mechanisms before delinquency appears, such as cutting back on discretionary spending, depleting savings, selling assets, or shifting to non-bank financial institutions.

While the overall household debt-to-nominal GDP ratio has decreased, Kim argues this metric alone is insufficient. He points out that nominal GDP growth can be driven by inflation or concentrated income gains in specific sectors, not necessarily by improved real income or repayment capacity for indebted households. The true measure of sustainability, he contends, lies in the growth of borrowers' cash flow and the structure of their debt, alongside the overall economic growth.

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Nominal GDP ratio decline does not necessarily mean relief in principal and interest payments for borrowing households, improvement in loan structures, or the productive sector's use of financial funds.

Kim urges a more nuanced approach to household debt management, advocating for policies that address the concentration of funds in real estate. He differentiates between loans for new housing supply and those for existing home purchases, noting the latter do not directly contribute to new production or income. He also expressed concern over frequent changes to the total household loan growth targets, which can undermine policy credibility. Kim proposes that the government clearly distinguish between loans for housing construction and those for existing home purchases, and disclose the breakdown of household lending by category.

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The sustainability of household debt should be judged based on the borrower's cash flow, repayment structure, and the use of funds, along with denominator growth.