Korea’s commercial banks face higher risk of deteriorating soundness

South Korea’s commercial banks are striving to improve their deteriorating indicators for financial soundness by writing bad loans off or opting to sell them amid rising interest rates and economic downturn, both of which have lifted delinquencies.

Local banks urgently need to manage their soundness, defined as delinquencies and non-performing loans. The loans written off or sold by the country’s top five lenders during the first half of this year amounted to more than 2 trillion won ($1.55 billion), similar to last year’s annual level. The country’s five banks refer to KB Kookmin Bank, Shinhan Bank, Woori Bank, KEB Hana Bank and NH Nonghyup Bank.

According to multiple sources from the financial industry on Monday, the five banks have written off or sold loans worth 2.21 trillion won in the first half.

When loans remain overdue for three months or longer, banks classify them as “sub-standard” and keep them in a separate category until there is a reasonable expectation of recovering the funds. Once they are deemed less likely to be repaid, the loans are reclassified as non-performing assets. Banks then write the bad loans off and sell them to specialized companies at rock-bottom prices.

While the write-offs are mostly credit-based loans without collateral, the sales include housing mortgages.

In the first half of this year, the write-offs and sales in volume surged to 2.23 times the volume recorded in the first half of last year. The growth has brought the current year’s volume close to the total volume of last year, which was 2.27 trillion won.

During the second quarter, a substantial amount of non-performing loans worth 1.35 trillion won was sold, including 1.26 trillion won sold in June alone. It was up 2.38 times compared to the second quarter of the previous year, with 570.9 billion won.

After a bank writes off or sells a bad debt, it is taken off its balance sheet, no longer considered as an “asset.” The bank then sees its delinquency or volume of non-performing loans fall despite a smaller size of assets.

In some cases, the sale of non-performing loans can result in either a gain or a loss on the income book.

For instance, if a bank had set aside a reserve of 3 billion won for 10 billion won worth of non-performing loans and later managed to sell them for 9 billion won, they could record other operating income of 2 billion won. However, if the loans were sold at a discounted price, it might lead to a loss even after accounting for the provision.

The delinquencies and volumes of non-performing loans at the top five lenders saw a slight decrease as a result of the large write-offs and sales in June.

As of the end of June, the average loan delinquency rate among the five banks was 0.29 percent. It showed a decline of 0.04 percentage points compared to the 0.33 percent reported at the end of May.

During the month, the volume of non-performing loans exhibited a decrease of 0.05 percentage points, declining from an average of 0.30 percent to 0.25 percent.

Despite the improvement, however, the soundness indicators for commercial lenders deteriorated compared to the previous year.

As of the end of June last year, the five banks reported average delinquency, new delinquency, and NPL volumes of 0.17 percent, 0.04 percent, and 0.22 percent, respectively. The figures were 0.12 percent, 0.05 percent, and 0.03 percent lower than the corresponding ratios recorded at the same point this year.

Industry insiders are concerned about the risk of delinquencies rising in the second half.

“Amid rising actual delinquencies, vulnerable or financially-crunched companies have suffered a prolonged economic downturn, which lifted their delinquencies,” said an unnamed official from a bank. “The delinquency rates will escalate even faster once the financial support related to the pandemic comes to an end.”

“Though pressure to further rate hikes subsides in the second half, an increase in delinquencies seems unavoidable for several reasons, including delayed recovery in housing prices suburb Seoul, and a shortage of demand for long term housing rental Jeonse,” said another official from an unnamed bank.