Approaching Interest Rate Cuts Spark Banking Sector Emergency Over Household Debt

With the likelihood of an interest rate cut by the Federal Reserve and the Bank of Korea increasing, the banking sector faces a state of emergency over household debt management.

With the likelihood of an interest rate cut by the Federal Reserve and the Bank of Korea increasing, the banking sector faces a state of emergency over household debt management. Rising household debt, stricter loan regulations, and falling deposit rates are causing significant shifts in the financial landscape. This article explores the current situation and its impacts on banks and consumers.

1. Interest Rate Cuts and Rising Household Debt

The Federal Reserve is expected to cut interest rates starting in September, leading to speculation that the Bank of Korea will also lower its benchmark interest rate (currently at 3.50%) as early as October. This imminent rate cut is raising alarms about household debt management. As housing prices in the metropolitan area have surged, household debt reached an all-time high of 1780 trillion won by the end of June. This increase is primarily driven by a surge in mortgage loans.

Banks have responded by tightening loan conditions, raising mortgage rates, and reducing loan terms and limits. Despite these measures, the growth in household debt remains stubbornly high. To address soaring housing prices in the metropolitan area, the government has introduced stricter loan regulations starting in September, including increasing the stress test interest rate for Total Debt Service Ratio (DSR) calculations.

2. Enhanced Mortgage Regulations in the Metropolitan Area

To curb rising housing prices in the metropolitan area, the government has raised the stress test interest rate for metropolitan mortgages from 0.75% to 1.2%. For example, with a 1.2% stress test interest rate, a borrower with an annual income of 50 million won will see their mortgage limit decrease from 329 million won to 287 million won. In contrast, non-metropolitan areas will have a lower stress test rate of 0.75%, resulting in a smaller reduction in mortgage limits.

3. Falling Deposit Rates and Capital Movement

The anticipated interest rate cuts are causing deposit rates to fall, impacting savers, particularly retirees who rely on interest income. Higher interest rates on one-year fixed deposits, which were available previously, are now nearly non-existent due to decreased borrowing costs for banks. The one-year bank bond rate fell to 3.22% last month, a significant drop from earlier in the year.

Ironically, as the rate cut approaches, a perception that “today’s rates are the highest” has led to a surge in deposits. In July alone, the deposits at the top five banks increased by 18.2 trillion won. This trend follows a three-month period of rising deposits.

However, with low deposit rates, funds are flowing into the stock market and real estate. On "Black Monday," when the KOSPI index dropped over 8%, 2.03 trillion won was withdrawn from demand deposits at the top five banks, while investor deposits in the stock market increased by 5.6 trillion won.

4. Rising Rates at Savings Banks

Despite the overall decline in deposit rates, some savings banks are increasing their rates to attract funds ahead of the anticipated rate cuts. As of the end of June, the balance of deposits in savings banks was 100.9 trillion won, the lowest since November 2021.

The approaching interest rate cuts are causing significant adjustments within the banking sector and financial markets. The combination of rising household debt, stricter loan regulations, and declining deposit rates highlights the need for careful financial planning. Consumers should stay informed and prepare for the potential impacts on their finances.