Korea’s Financial Services Commission Announces Tighter Regulations on Household Loans

Date Published 7/5/2011
Author Marja Hoek-Smit
Country Korea, Republic of

Korea's Financial Services Commission (FSC) announced that it will later this year put into effect stringent regulatory measures to curb the high and rising financial leverage of Korean households, and its intention to adopt even stricter measures if these steps are insufficient to achieve the commission’s objectives. Banks have been competing for clients, increasingly using collateral value rather than a prudent analysis of borrowers’ cash flows as the basis for lending.  

The FSC outlined four areas of the regulatory framework:
  • “A requirement by 2016 for banks to increase to 30% the proportion of mortgages with fixed interest rates or without principal deferral from their current 5% level in their mortgage books”
  • “An increase in the risk weighting of certain mortgages for the purpose of calculating Bank of International Settlements (BIS) capital ratios”
  • “A prohibition on bank management considering household loan growth when evaluating their branches’ performance”
  • “Prudential requirements on non-banking financial institutions”  

There are some risks associated to these measures. First, increasing Fixed-Rate-Mortgages in the banking system from 5% to 30% by 2016 will mean increased competition in that market segment, at least initially, and reduced margins on FRM relative to floating rate mortgages. Second, fixed rate instruments are more likely than floating-rate mortgages to be pre-paid when market interest rates are falling and banks will have to improve their capacity to manage the risks arising from mismatches in interest rates or maturities of assets and liabilities. 

State-owned Korea Housing Finance Corporation, which has a public mandate to facilitate the supply of long-term fixed rate mortgages, will be asked to extend its guarantee programs for mortgage-backed securitizations and covered bonds issued by the banks.  

Raising risk-weightings will be applicable to more risky loans, but details were not provided.With the average Tier 1 capital ratio of 11.3% (March 2011) the negative effect of this higher risk weight on BIS capital ratios should not be a major constraint for the banks.  

The gradual application of prudential requirements on non-banking financial institutions such as credit card companies and mutual financial institutions is a response to the steep increase in household borrowing from non-banking financial institutions; loans from NBFI grew 11.4% per year during 2007-10, compared to 5.7% annual growth of banks loans. The prudential requirements include setting annual growth targets for credit cards, adopting leverage ceilings and raising regulatory minimum ratios for credit-loss reserves.

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