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[Editorial] Defusing debt bomb

April 21, 2011 - 18:36 By 류근하
The Korean economy is sitting on a ticking time bomb ― household debt that has topped 800 trillion won. To figure out the risks that this huge debt bomb poses to the national economy, one has only to remember that one percentage point hike in interest rates would increase the interest payment burden on households by 8 trillion won a year. No wonder the Bank of Korea has been hesitant to raise the key rate despite growing inflationary pressure.

To prevent the debt bomb from detonating, officials at the Financial Supervisory Commission have been racking their brains since January. They said they would come up with a comprehensive package in May. But prior to that, they disclosed part of the package on Monday, which was aimed at protecting low-income earners, the most vulnerable group to any attempt to curb debt growth.

The FSC’s scheme calls for helping people with low credit ratings improve their ratings to the sixth grade, the threshold for access to bank services. For this, the commission will ensure that overdue payments of less than 100,000 won would no longer affect borrowers’ credit ratings. This measure alone, it said, would benefit 7.5 million people.

The commission also plans to make credit inquiry records irrelevant to the assessment of individuals’ credit ratings. Currently, when a person applies for a loan, the financial company checks his rating. Each time an inquiry is made, his credit rating is downgraded by one notch. The FSC said stopping rating inquiries from affecting credit ratings would benefit more than 3 million people.

The regulator will also seek to lower the annual interest rate ceiling for loans extended by private money lenders from the present 44 percent to 39 percent. At the same time, it intends to bring down the cap on loan brokerage fees from the current 7-10 percent to 3-5 percent and crack down further on illicit brokerage practices.

These and other measures promoted by the FSC will no doubt give a break to low-income households. But they obviously have limits in helping low-income people pull themselves out of debt. What these people need most is an opportunity to make sufficient income. If they make enough money, they can pay off their debts. But this can only be done by creating more decent jobs for them. Hence the financial regulator needs to study ways to make such jobs available for them.

To defuse the household debt bomb, one urgent task facing the FSC is to help banks restructure mortgages, which account for the lion’s share of their lending to households. Currently, about 90 percent of mortgages are at floating market rates, exposing borrowers to extra costs when interest rates rise. Furthermore, more than 80 percent of these loans are three-year “bullet loans,” in which borrowers only pay interest during the grace period, with the entire principal repaid at the end of the term.

These loans need to be converted into long-term, fixed-rate amortizing loans to bring household debt under control. The availability of long-term, low-cost mortgages could also stimulate demand for homes, helping indebted home owners dispose of their houses and repay their debts. Increased demand could also put a floor under falling home prices.

For the restructuring of home loans, however, banks need to be able to secure long-term funds by securitizing their mortgages. This calls for a system that protects investors who purchase these bonds. But currently, such a system is absent in Korea, making mortgage securitization costly. Therefore, the financial regulator’s task is to promote legislation that can lower the cost of securitization.