47.5% of Low-Income Households with Debt Face Direct Interest Rate Hit as Rates Rise... "Delinquency Rates May Climb Rapidly" [Financial Stability]

Bank of Korea's Financial Stability Report

Concerns Over Household and Self-Employed Vulnerabilities Amid Rate Hikes
28.6% of Households and 47.2% of Companies Face Rising Net Interest Burdens
Asset Price Growth Curbed, Raising Hopes for Redu

The Bank of Korea has found that nearly half of low-income households with financial debt could face a debt repayment crisis due to rising interest rates. The analysis also shows companies, specifically marginal firms and vulnerable self-employed borrowers, have a diminished ability to cope with the rate hikes. Although, on average, the debt ratio has fallen compared to previous base rate hike cycles—indicating improved overall resilience—there are calls for close monitoring because these vulnerable sectors could again increase the risk of default throughout the financial system.

"Interest Rate Hikes, No Room to Maneuver"... 47.5% of Low-Income Households at Risk of Debt Repayment Crisis

On September 22, the Bank of Korea stated in its Financial Stability Report that the negative impact from higher lending rates could be felt more quickly and sharply, especially among vulnerable groups with weakened debt service capacity, if the base rate rises.

According to household financial and welfare survey data analyzed by the Bank of Korea, 47.5% of low-income households (the first income quintile) would see their net interest burden increase if rates rise, far exceeding the 28.6% figure for all households. Among listed companies, the proportion is estimated at 47.2%. This means that, within the next year, these groups hold more short-term debt subject to interest rate changes than financial assets, exposing them to potential negative interest income.

Low-income households were also found to have a relatively high interest burden in proportion to their disposable income. Among households holding financial debt, the ratio of net interest income to disposable income worsened from -5.3% in March 2024 to -6.3% in March 2023, but for low-income households, it dropped to -14.0%, significantly below the overall average. To put it another way, for each 1 million won of disposable income, ordinary households pay around 63,000 won in interest, while low-income households pay about 140,000 won.

For companies, the capacity to cope with interest rate hikes has deteriorated among marginal firms and vulnerable self-employed borrowers. According to the Bank of Korea, the proportion of vulnerable household borrowers stood at 6.8% in the second quarter of last year, remaining in the 6% range since 2020. However, for marginal firms, the share rose from 15.3% in 2020 to 19.1% by the end of last year. Among self-employed individuals, those classified as vulnerable also showed higher levels for both the delinquency entrance rate (3.60%) and the sustained delinquency rate (82.3%) as of the end of the second quarter this year, compared to non-vulnerable borrowers (0.6% and 78%, respectively). This suggests that if debt repayment conditions deteriorate, the likelihood of delinquency will become even greater among these groups.

There is also a possibility that delinquency rates could rise more swiftly. The Bank of Korea’s analysis of past hiking cycles since 2012 showed that delinquency rates for household vulnerable borrowers and SMEs spiked sharply around nine months after rate hikes, rising faster than the overall average of 15 months. In particular, for vulnerable household borrowers, the delinquency rate reached 10.39% in the second quarter of this year, which is higher than during previous hiking cycles—7.3~9.16% (2017–2018) and 6.72~9.33% (2021–2023)—reflecting further deterioration in repayment capacity.

The Bank stated, "Households and firms lacking sufficient financial assets or income buffers will find it hard to absorb increased interest expenses on their own, so their debt repayment capacity may quickly decline as interest rates rise." The Bank added, "There is also a risk of a vicious cycle, where rising delinquencies among vulnerable groups trigger credit downgrades and weaker refinancing terms, in turn causing further delinquencies."

Effects of Rate Hikes Become Clear After 5 Months..."Rate Hikes Will Help Ease Financial Vulnerability"

The report suggests that the main impacts of this rate hike cycle will likely become apparent after about five months.

According to the Bank of Korea, balance-based lending rates (the average interest rate applied to the total outstanding loan balance), which reflect actual interest costs for borrowers, respond most strongly around five months after a base rate hike. Bank delinquency rates are affected from 15 months after a rate hike.

Still, the Bank observed that the average ability of households to cope with rate increases is better in the current cycle than in previous ones, citing improvements in the debt ratio and a decline in the debt service ratio (DSR). The proportion of variable-rate loans also declined markedly, from 68.4% in July 2021 to 56.1% at the end of June this year.

Moreover, the Bank said that the rise in the base rate should help contain the upward trend in asset prices, thereby easing overall financial vulnerability (FVI).

The FVI recorded 46.5 in the second quarter of this year, continuing a recent upward trend. In particular, there is mounting pressure for asset prices—especially housing—to rise further. Analysis by the Bank shows that if the FVI climbs by one point, the 5th percentile of economic growth can fall by up to 0.19 percentage points, which could amplify real economy contractions.

The Bank of Korea explained, "History shows that in the lead-up to major episodes of financial instability, the FVI also tended to rise; therefore, this rate hike should limit the excessive increase in financial vulnerability and help reduce overall financial stability risks." The Bank added, "In previous periods when monetary policy shifted to tightening, the FVI, particularly in the asset price sector, also showed a declining trend."

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