The Bank of Korea predicted that the recent increase in the base interest rate will contribute to alleviating financial vulnerabilities caused by accumulated household debt and rising housing prices in the metropolitan area.
However, it was believed that the rise in loan interest rates due to interest rate hikes could increase the borrower's interest burden and risk of delinquency over time.
In the financial stability report released on the 23rd, the Bank of Korea stated that raising the base interest rate could help alleviate financial vulnerability by limiting the upward trend in asset prices.
The Financial Vulnerability Index (FVI) is showing an upward trend centered on asset prices such as housing prices. FVI has steadily risen for 9 quarters, from 37.6 in the first quarter of 2024 to 46.5 in the second quarter of this year.
However, the Bank of Korea believed that the interest rate hike had the effect of lowering expectations of a rise in housing prices by weakening borrowing incentives and risk preference.
In fact, after the change in monetary policy tightening in the past, FVI showed a decline centered on the asset price sector over time.
Eight quarters after the base interest rate increase, the credit index fell by 1.3 and the asset price index fell by 4.5.
Assistant Vice-Governor Jang Jeong-soo said, "FVI rose to the long-term average in the second quarter of this year, and the upward trend is expected to continue in the third quarter," adding, "The consecutive interest rate hikes in July and August and the government's announcement of real estate measures are expected to act as factors limiting the increase in FVI."
However, an interest rate increase also has the side effect of increasing the interest burden on borrowers through a rise in market interest rates.
In particular, as the strengthening of household loan management and the policy of expanding corporate loans through productive finance coincided, the interest rates on household loans rose significantly more than the interest rates on corporate loans.
The loan interest rate, which was 4.31% per annum last May, rose to 4.34% in June and 4.37% in July.
The Bank of Korea estimated that the loan interest rate reacted the most after about 5 months and the bank delinquency rate after 15 months after the base interest rate increase.
Lim Kwang-gyu, Director of the Financial Stability Bureau, explained, “If the interest rate rises by 0.25%, the interest burden for households will increase by 3.3 trillion won and for businesses by 3.7 trillion won.”
The average response capacity of households is better than in past hikes.
The proportion of variable-rate loans fell from 68.4% at the end of July 2021 to 56.1% at the end of June 2026, and the proportion of vulnerable household borrowers also remains at a relatively low level of around 6-7%.
The burden on companies is relatively high. The debt ratio and interest coverage ratio are generally at the long-term average level, but the delinquency rate and proportion of variable interest loans are higher than in past increases.
Accordingly, the proportion of marginal companies also increased from 17.1% in the fourth quarter of 2024 to 19.1% in the fourth quarter of last year.
However, the Bank of Korea predicted that the recent improvement in the economy and the easing of the additional interest rate burden due to incentives to expand corporate loans will partially offset the pressure to raise interest rates.
The Bank of Korea said, "The negative impact of a rise in loan interest rates may be felt relatively quickly and significantly in vulnerable sectors with low repayment capabilities," and added, "We must be mindful of the possibility that a vicious cycle may occur where increased delinquency in vulnerable sectors leads to additional delinquencies due to a decline in credit rating and worsening refinancing conditions."
Director Lim emphasized, "Monetary policy and macroprudential policy must be operated in a complementary manner, and in areas where financial instability increases as interest rates rise, complementary policy coordination must be achieved through fiscal policy."
