BOK Rate Hikes to Hit Vulnerable Household Borrowers First
The Bank of Korea has diagnosed that when it raises the base rate, the fallout may quickly hit household borrowers and small businesses that lack the means to repay their debts. Here, 'vulnerable borrowers' refers to debtors with limited capacity to repay relative to their income or assets; as rates rise, their interest burden grows and they are the first to fall into distress. This is according to the Financial Stability Report released by the Bank of Korea on the day.
The BOK assessed that the domestic financial system is, on the whole, maintaining a stable trajectory, supported by financial institutions' capital and liquidity buffers. However, it cited financial imbalances stemming from household credit growth and rising home prices, along with the risk of distress in vulnerable sectors, as key sources of instability. The central bank raised the base rate by 0.25 percentage points in both July and August, marking two consecutive hikes. Rate increases curb demand for borrowing and risk appetite, restraining the rise in household debt and asset prices. But rising market and lending rates also bring a heavier interest burden for households and businesses.
Households' overall capacity to absorb rate increases has improved compared with previous hiking cycles. The share of variable-rate loans fell from 68.4% at the end of July 2021 to 56.1% at the end of June this year. The delinquency rate on household loans at financial institutions also edged down to 0.98% in the second quarter of this year, from 1.00% in the previous quarter. Even so, the share of vulnerable borrowers by headcount rose over the same period, from 6.7% to 6.8%.
Distress indicators for vulnerable sectors are already elevated. As of the end of the second quarter, outstanding loans to self-employed individuals stood at 1,098.5 trillion won, up 5.6 trillion won from the end of last year, while their delinquency rate climbed from 1.86% to 1.99%. The delinquency rate on self-employed loans at non-bank institutions reached 3.86%, and that of vulnerable self-employed borrowers hit 12.71%. The number of vulnerable self-employed individuals also rose from 404,000 at the end of last year to 411,000 in the second quarter of this year.
Pressure is also mounting on the corporate sector. The delinquency rate for small and medium-sized corporations rose from 2.88% in the fourth quarter of last year to 3.44% in the second quarter of this year, while that of individual business owners climbed from 1.89% to 2.22% over the same period.
The BOK analyzed that there is a considerable time lag before the effects of a base rate increase are reflected in lending rates and delinquency rates. Reviewing data from 2007 through June of this year, it estimated that banks' loan rates, on an outstanding-balance basis, respond most strongly about five months after a rate hike, while the impact on banks' overall delinquency rate peaks at around 15 months. Vulnerable sectors react faster: delinquency rates on loans to vulnerable household borrowers and small businesses showed the greatest impact roughly nine months after a hike.
The central bank said financial institutions' capital and liquidity buffers remain above regulatory requirements to date.
