[Editorial] Tackling household debt

The financial regulator has come up with a packages aimed at defusing the ticking household debt bomb. The measures, unveiled Wednesday, appeared more focused on slowing the rapid growth of household credit and gradually changing the debt profile than on offering incentives for indebted households to pay down their loans.

Korea’s household credit, including loans and credit purchasing, stood at 801.4 trillion won as of the end of March. The debt volume is excessive when seen in terms of households’ ability to repay. In 2009, the liabilities of households exceeded their disposable incomes by 1.53 times, worse than OECD average of 1.34 times.

A more troubling aspect is the rapid pace of debt growth. According to the Financial Supervisory Commission, Korea’s household debt increased by an average of 13 percent annually between 1999 and 2010, almost double the nation’s GDP growth rate of 7.3 percent per year during the period.

Another cause for concern is the unstable debt structure. According to the FSC, more than 95 percent of home-backed loans are at floating interest rates, exposing households to greater risks when interest rates are on the rise. Furthermore, some 80 percent of the loans are so-called “bullet loans” ― loans for which borrowers only pay interest during the grace period, with the entire principal repaid at the end of the term.

To curb debt growth, the FSC plans to squeeze banks’ lending capacity by requiring them to lower their loan-to-deposit ratios. Banks were initially told to bring down their ratios to 100 percent by the end of 2013, but the FSC plans to move up the schedule to June 2012 and further lower the ceiling to 90 percent.

As of March, the average loan-to-deposit ratio of the 13 domestic banks was 97.1 percent. According to the FSC, a 10 percentage point cut in the ratio would reduce bank lending by around 100 trillion won.

To change the debt profile, the financial regulator will require banks to increase the share of long-term, fixed-rate amortizing loans in their mortgage lending from the present 5 percent to 30 percent by 2016.

This target had banks scratching their heads. To attain it, banks should in the first place be able to raise low-cost long-term funds. Otherwise, they won’t be able to offer fixed-rate amortizing loans that carry lower interest rates than floating-rate loans. But currently, there is no domestic capital market that banks cap tap to secure long-term funds at low costs.

One way banks can secure long-term funds is to issue “covered bonds” backed by cash flows from their mortgage loans. But to issue these bonds, they need payment guarantees. The FSC said it has revised rules to have Korea Housing Finance Corp. provide the guarantees. But this and other expenses involved in issuing the bonds would boost the borrowing costs to above 5 percent per year, much higher than the 3 percent banks now pay for short-term funds.

To encourage households to switch from floating-rate bullet loans to fixed-rate amortizing products, the FSC came up with one incentive ― exemption of the conversion fees. But this is not a big enough incentive. To facilitate the conversion, banks should be able to offer cheaper, longer-term amortizing loans. For this, the FSC needs to find ways that would enable banks to issue bonds at lower costs.