[Editorial] Rate Hikes Require Close Monitoring of Vulnerable Borrowers and Timing Effects

With the Bank of Korea raising its benchmark interest rate twice in July and August, the rate, which had stood at 2.5% per annum, has now reached 3.0%. This change is leading to increased funding costs for both households and businesses. In particular, as policies such as stricter management of household loans and an expansion of productive finance take effect, interest rates on household loans from banks are rising faster than those on corporate loans.

According to the "Financial Stability Situations" report released by the Bank of Korea on September 22, the impact of interest rate hikes appears with a time lag. Empirical analysis using historical data estimates that banks' loan interest rates based on outstanding balances respond most strongly about five months after the base rate hike, while delinquency rates show the greatest response about 15 months later. This is because it takes time to reassess interest rates on existing loans, and there is also a lag before the increased interest burden leads to more delinquencies. That is why it is difficult to judge the impact of rate hikes based solely on the current delinquency rate or the ratio of non-performing loans.

Fortunately, the average ability of households to cope with such increases has improved compared to previous rate hike cycles. Both the debt-to-income ratio and the debt service ratio (DSR), which measures principal and interest payments relative to income, have decreased. The proportion of variable-rate loans has also declined from 68.4% at the end of July 2021 to 56.1% at the end of June this year. However, improvements in averages do not guarantee security for vulnerable segments. As of the second quarter of this year, the proportion of at-risk borrowers among households—those who are both multiple debt holders and in the bottom 30% income bracket—rose slightly to 6.8%. Among companies, the share of marginal firms with an interest coverage ratio below 1 for three consecutive years increased to 19.1%. This means that shocks may first be concentrated in areas with poor repayment capability.

Monetary policy responses to maintain price and financial stability are necessary. At the same time, it is important to prevent the burden on vulnerable segments from spiraling into insolvency. Financial authorities and institutions should proactively check the timing of interest rate reassessments for each borrower, loan maturity, and their capacity to repay based on income and cash flows. For borrowers experiencing temporary liquidity shortages, they should assess repayment ability and offer debt restructuring and support when needed. It is also necessary to assess the loss-absorbing capacity of financial institutions. Although there is a time lag in the transmission of interest rate hikes, efforts to prevent insolvencies must not be delayed.

This content was produced with the assistance of AI translation services.