The Korea Herald


[Editorial] Tackling financial fallout

Government has to map out fair and specific plans in implementing debt relief programs

By Korea Herald

Published : July 18, 2022 - 05:30

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The South Korean government plans to implement a set of support measures to help small businesses and financially vulnerable people hit hard by soaring debt burdens sparked by a series of interest rate hikes in recent months. But there are worries that the government will find it hard to work out thorny issues such as maintaining fairness and preventing moral hazard.

The government unveiled a 125 trillion-won ($94.7 billion) support package to stabilize the private financial sector Thursday, including debt relief programs. The next day, it announced an additional plan to offer policy financing valued at 68.3 trillion won to help small businesses and other vulnerable people struggling to handle interest payments.

The plans came after the Bank of Korea raised the benchmark interest rate by 0.5 percentage point Wednesday to rein in runaway inflation. Higher borrowing costs are expected to place extra burden on small merchants hit hard by the pandemic and individuals who took out bank loans.

“In tackling financial risks, proactive policies are more important than follow-up measures,” President Yoon Suk-yeol said Friday. Given the potential risks that could bring about a much-feared economic downturn linked to deeper financial troubles of companies and households, it is a timely move for the government to come up with a support package to help debt-laden small businesses and low-income earners avoid bankruptcy.

The central bank raised the benchmark rate to 2.25 percent Wednesday by delivering an unprecedented rate hike of 0.5 percentage point. With the sixth rate increase, the Bank of Korea bumped up the rate by a total of 1.75 percentage points since last August.

According to the central bank, the country’s household loans amounted to 1,752.7 trillion won as of end-March this year. More important is that the proportion of loans based on variable rates accounts for 77.5 percent of the total, a fairly high level. Considering the burdensome amount of total household loans and a higher ratio of those on floating rates, the outlook for higher interest rates could pose a serious challenge for policymakers as well as those who have to live with rising interest payment.

According to the Bank of Korea, a quarter percentage point increase of the benchmark rate translates to an increase of 3.4 trillion won in interest payment for households. Compared with last August, each individual borrower faces an increase of 1.12 million won in interest payments.

Since large numbers of those bank loans were used to buy houses, a slump in the real estate market could spark a toxic chain reaction in which a number of borrowers would fail to pay interest or, in worse cases, go bankrupt -- a scenario that will slam local banks and send extra shocks to the economy beleaguered by a slew of risks.

A closer look at the government’s support programs, however, reveal the lack of specific plans and the possibility for a dispute over moral hazard. First, the government announced it would ask banks to extend up to 95 percent of COVID-related loans, which are set to mature by end-September. It will allow banks to make decisions “voluntarily” on loan extensions, but it runs counter to the government’s extension target of up to 95 percent. To prevent risky loans from going sour after artificial extensions, the government should let banks to make decisions without specifying artificial targets.

Second, the government should consider the principle of fairness and take steps to minimize moral hazard by balancing its new debt relief program. Writing off up to 90 percent in the amount of principal due or in arrears, targeting select small merchants, or forgiving up to 50 percent of principal for young people could touch off controversies about fairness.

Proactive financial policies are necessary at this critical juncture, but the government should carefully weigh pros and cons of its proposed debt relief programs.