Bond Yields Surge as Loan Caps Hold... Authorities, Banks in a 'Dilemma' Over Assembly's Criticism of 'Rate Tricks'

FSS Weighs More Detailed Disclosures of Preferential Rates
Rising Funding Costs and Credit Risks Limit Scope for Rate Cuts
Pressure for Artificial Cuts Could Trigger a "Loan Rush" and Push Borrowers Toward Non-Bank Lenders

With rising global bond yields and the government’s cap on total household lending limiting banks’ room to cut loan rates, pressure from the National Assembly to lower rates has left financial authorities and banks caught in an “interest rate dilemma.” Concerns are growing that artificially pushing rates down on the grounds that banks are making record-high profits, while ignoring market conditions and regulatory realities, could distort how rates are set and have the unintended effect of driving borrowers to the non-bank financial sector.

According to financial authorities on October 31, the Financial Supervisory Service (FSS) is considering plans to provide more detailed disclosures of preferential rates offered by banks and to incorporate the appropriateness of their rate-setting systems into assessments of their consumer protection practices.

An FSS official said, “We are looking at ways to make disclosures of each bank’s rate-setting system, including preferential rates, more detailed. We will also examine whether any aspects of the rate-setting process work to consumers’ disadvantage and reflect our findings in assessments of consumer protection practices.”

The move follows comments made on October 22 during an FSS parliamentary audit by Min Byung-deok of the Democratic Party of Korea, who criticized banks’ rate-setting methods. He argued that although amendments to the Banking Act that took effect in July excluded certain statutory costs from the calculation of additional interest rates, banks had used a “loophole” by reducing preferential rates, preventing loan rates from falling as much as expected. At the time, FSS Governor Lee Chan-jin said the agency would consider strengthening disclosures of rate-setting systems and reflecting them in consumer protection assessments and evaluations of inclusive finance performance.

Banks currently disclose loan rates by separating them into a base rate, an additional rate, and an adjustment rate (preferential rate). The FSS is expected to require banks to break down the adjustment rate into, for example, discounts tied to ancillary transactions such as salary deposits and card spending, and adjustments made by head offices or branches. It is also considering disclosing separately some components of additional rates, including risk, liquidity and credit premiums, operating costs, and expected profit margins. The aim is to improve transparency so consumers can compare how rates are set at different banks.

Internally, however, the FSS appears to be in a difficult position over the National Assembly’s criticism of banks’ “trick” rate practices. Loan rates are market prices determined by factors including funding costs, credit risk and banks’ business strategies, while recent increases in market rates have raised both banks’ funding costs and the risk of borrowers defaulting. As a result, the agency has few concrete options beyond increasing transparency around rate-setting, and stronger disclosure requirements are unlikely to lower loan rates in the near term.

A financial authorities official explained, “Although statutory costs were removed from the components of additional rates, other costs, such as credit costs and liquidity premiums, have actually risen as rates have gone up. If banks recalculate these costs precisely and reflect them in their rates, additional rates could end up higher than they are now.” The official added, “The problem is that banks have responded in a simplistic way by sharply reducing preferential rates instead of directly reflecting the factors driving up costs in their additional rates.”

In practice, market conditions surrounding loan rates remain challenging. Inflation concerns have grown as oil prices have risen amid the war in Iran, and the yield on 10-year U.S. Treasury bonds, a benchmark for interest rates worldwide, has climbed sharply from around 4.1% at the start of the year to nearly 4.9% now. The financial authorities’ cap on total household lending is another factor limiting rate cuts. Although the target for managing household loan growth this year was eased from 1.5% to 3.0%, the policy of restraining loan supply remains in place. To meet their lending targets, banks have little choice but to manage loan demand by raising additional rates or reducing preferential rates.

The concern is that if authorities push for rate cuts while keeping loan supply constrained, conflicting policies could end up harming consumers. If lower rates attract a surge in demand, banks could exhaust their lending limits early, triggering a “loan rush,” or tighten their credit screening. As a result, borrowers who need funds even at high interest rates may be unable to get past the banks’ lending criteria and could be pushed toward the non-bank financial sector, where rates are relatively higher.

A commercial bank official said, “We agree with the goals of improving transparency in rate-setting and easing the burden on borrowers, but loan rates are determined by market conditions, including funding costs and credit risk. If disclosures become overly detailed, banks’ discretion in managing rates and their business strategies could be constrained, and competition to cut rates could also be dampened, reducing benefits for consumers.”

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