Last month, domestic banks were criticized for abruptly halting the extension of fresh loans to households. They took the surprise move to comply with the regulator’s policy to rein in household debt. But it was an act that totally ignored the inconvenience that people in urgent need of loans would experience.

This month, banks lifted the temporary suspension on new loans to households. But they are tightening up further on household loans under pressure from the Financial Supervisory Commission.

Banks have already abolished their prime rates on fresh household loans. This has the effect of raising lending rates on home loans by 1-2 percentage points. The rate hike is expected to discourage demand for new loans to some degree.

At the same time, lending rates on outstanding loans have increased due to the rise in certificate of deposit (CD) rates, the benchmark for borrowing costs of local banks. CD rates are currently in the 5.2-6.6 percent range, up 0.8 percentage points from the 4.4-5.8 percent level last year.

As a result of the hike in CD rates, households’ interest burden is expected to rise by some 4 trillion won a year as around 60 percent of the household loans, which are approaching 900 trillion won in total, are pegged to CD rates.

The rise in CD rates reflects the ample liquidity at banks. Banks are awash with cash these days due to a sharp increase in deposits. Despite low interest rates, funds are flowing into banks as investors search for safety. Consequently banks do not feel the need to issue CDs to raise short-term funds. This keeps CD rates at a high level.

Banks have also launched efforts to induce borrowers to repay their loans. For instance, they are pressing borrowers to offset their maturing loans with deposits or repay part of them in return for new loans.

Increasing pressure on borrowers to repay their loans is a step in the right direction, given that putting a lid on demand for fresh loans alone would not be enough to scale back the debt mountain. While the size of the debt is staggering, the rapid pace of growth is more alarming. This year, household loans increased by over 30 trillion won to August, with 10.2 trillion won added in July and August alone.

The regulator’s tightening policy has proved to be a boon for banks as they are allowed to raise lending rates without making a corresponding hike in deposit rates. In fact, banks are lowering deposit rates as market interest rates are on a downward curve. The average interest rate offered by local banks on one-year fixed deposits fell from 4.19 percent a year at the beginning of the year to 4.05 percent this month.

As a result, the gap between lending and deposit rates has widened, boosting banks’ profits. The difference between the two rates remained in the 2 percentage points range between 2007 to 2010. But it has stayed above 3 percentage points since March this year. Consequently, banks are poised to enjoy a record profit this year.

Domestic banks need to bolster their profitability in the face of worsening turmoil in the eurozone. When banks in this region run into trouble, domestic banks suffer the fallout. Should another crisis occur, solid profitability will help them weather it.

But the financial regulator needs to see the other side of the coin, as a rise in bank profits implies an increase in households’ interest burden. The regulator needs to review banks’ new business practices and see whether they are earning excessive profits at the expense of their customers.