Winston T. H. Koh

English

Research Papers in Economics

This PDF is a selection from a published volume from the National Bureau of 
Economic Research
Volume Title: Financial Sector Development in the Pacific Rim, East Asia 
Seminar on Economics, Volume 18 
Volume Author/Editor: Takatoshi Ito and Andrew K. Rose, editors
Volume Publisher: University of Chicago Press
Volume ISBN:  0-226-38684-8
Volume URL: http://www.nber.org/books/ito_07-2
Conference Date: June 22-24, 2007
Publication Date: February 2009
Chapter Title:   Comment on "Consumer Credit Market in Korea since the 
Economic Crisis"
Chapter Author:  Winston T. H. Koh 
Chapter URL: http://www.nber.org/chapters/c0412
Chapter pages in book: (196 - 200)Shin, I., C. Hahn, and C. Park. 2003. The causes of increase in credit delinquents and
policy tasks (in Korean). KDI Policy Report. Seoul: Korea Development Insti-
tute.
Shin, I., and C. Park. 2006. Credit information system in Korea: Current condition
and policy priorities(in Korean). KDI Policy Report. Seoul: Korea Development
Institute.
Comment Winston T. H. Koh
The chapter examines the events surrounding the rapid expansion of
household debt in South Korea since the foreign exchange crisis that Ko-
rea suﬀered in 1997, which occurred as part of the Asian Financial Crisis.
A speciﬁc focus of the chapter is to investigate the developments in the
housing loan market and the credit card crisis in 2003, and the government
response to address the issues in both the housing loan market and the
credit card industry. The chapter argues that the crisis stems from regula-
tory failure, and with timely and proper regulatory actions, much of the
diﬃculties that occurred in the credit card market would have been allevi-
ated or averted.
I will make two general comments about the chapter, before going into
the speciﬁc comments. Firstly, in light of the intersecting sets of issues dis-
cussed in the chapter, it would be useful to provide, as a backdrop to the
analysis, a brief discussion of the state of the South Korean economy since
1997, in terms of rate of gross domestic product (GDP) growth, foreign in-
vestment inﬂow, current account deﬁcit, and so on in order that the reader
can better appreciate the forces driving the economy and understand the
impetus for the business strategies of the banks and credit card companies
and the government’s responses. In particular, it would be useful to ﬁnd out
if there were certain macroeconomic conditions that had prevented the au-
thorities from taking certain preventive or corrective actions to address the
developments in the credit markets.
Second, to the extent that data are available, it would be interesting to
analyze the data by age of household head as well as by income/assets to
gain a fuller picture. Table 5.1 and 5.2 look at household debt by age and
income/asset holdings, respectively. It would be interesting to analyze the
data by age of household head as well as by income/assets, if the data are
available.
196 Chang-Gyun Park
Winston T. H. Koh is an associate professor of economics and associate dean of the School
of Economics at Singapore Management University.Bank Lending to the Housing Market
The chapter noted that the household debt market in Korea has under-
gone three distinguished phases since 1997:
• The ﬁrst phase was from 1997 to 1999, when household debt fell
sharply due to monetary tightening in the aftermath of the 1997 eco-
nomic crisis in Korea.
• The second phase was from 2000 to 2002, when household debt ex-
panded sharply, recovering to the precrisis level. Debt-to-income ratio
rose from 63.8 percent at the end of 1999 to 113.3 percent in 2002,
while the debt-to-asset ratio also rose considerably, from 40.1 percent
at the end of 1999 to 51.8 percent in 2002.
• The third phase was from 2003 onward, the expansion in household
debt came to a grinding halt, and the ﬁnancial sector went into an-
other crisis.
As described in the chapter, three factors were behind the developments.
The ﬁrst and most obvious factor is the prevailing low interest rate envi-
ronment. Interest rates in Korea fell since 1999, as the authorities eased
monetary policy after the economy had stabilized following the economic
crisis in 1997 to 1999. The low interest rates led to increased borrowings
from households, particularly in collateralized housing loans.
Next, ﬁnancial sector deregulation led to a shift in the business strategy
of ﬁnancial institutions. Before the Asian ﬁnancial crisis, Korean banks
were urged by the government to lend to Korean conglomerates, or chae-
bols. As the author noted, “proﬁtability of individual banks was not a pri-
mary concern as long as banks served the policy goals set by the govern-
ment.” Following the Asian ﬁnancial crisis, the policy stance in ﬁnancial
regulation shifted toward one of fostering market eﬃciency in the credit
markets. Financial institutions are now free to set their interest rates and
prices for the services they provide. Entry barriers to the ﬁnancial sector
have been lowered, and foreign players are now welcome to establish local
subsidiaries or acquire domestic ﬁnancial institutions.
Finally, driven by the need to maintain the bottom line, banks turned
their attention away from loans to the corporate sector, which were deemed
to be riskier, to loans to the household sector, which were considered more
lucrative and less risky than loans to the corporate sector. Moreover, in the
restructuring that the Korean economy went through following the 1997 ﬁ-
nancial crisis, the focus of funding by Korean corporates shifted away from
bank loans to fund-raising via bond and share issuance in the capital mar-
ket. Hence, the increase in attention by banks toward the household sector
coincided with a reduction in demand for bank loans from the corporate
sector.
Consumer Credit Market in Korea since the Economic Crisis 197During the ﬁve-year span from 2001 to 2005, it is reported that 71 per-
cent of the increase in household debt provided by banks was attributable
to increase in loans secured by residential properties (LSRP). Loans by
banks to households rose from an average prevailing rate of below 30 per-
cent of the total loan portfolio in 1998 to reach 49.8 percent in 2005, sur-
passing the loans to the corporate sector for the ﬁrst time. Loans to house-
holds secured by residential properties rose from 47.8 percent at the end of
2000 to reach 62.4 percent in 2005.
The natural question to ask is why banks were willing to increase their
exposure to the real estate sector so sharply. Was the real estate market in
Korea experiencing a boom during the period under study? If there was in-
deed a boom in the Korean real estate market (and other asset markets)
during this period, then the increase in household debt may not appear to
be a problem, at least from the banks’ perspective, since the net asset value
of households has also increased sharply during this period. As noted in
the chapter, information on the aggregate asset holdings by households is
not available. Nonetheless, it would be very helpful if the author could pro-
vide some data and analysis of the real estate market during this period. In
fact, there might exist an “irrational exuberance-type” explanation for the
euphoria in the banking sector in increasing its exposure to the real estate
market. A booming real estate market coupled with increased competition
among banks to lend to households is likely to lead to an underpricing of
default risk in the real estate markets—as was found to be the case in many
Asian countries in the run-up to the Asian ﬁnancial crisis.
Changing Structure of the Mortgage Loans
The housing market in Korea also turned out to possess several features
that distinguish it from the typical long-term mortgage loan market that
exists in other countries (as shown in table 5.6 in the chapter). Housing
loans in Korea are short in maturity (typically one to three years) and are
not amortized over the tenure of the loans. These housing loans are re-
ferred to as bullet mortgages. Interest payments are made monthly, and at
the maturity of the housing loan, the principal is either rolled over or re-
paid. Loan quantum to asset value is typically less than 60 percent of the
value of the properties, compared with the usual 70 percent or more in the
conventional mortgage loan markets in other countries.
In taking on a bullet mortgage rather than a conventional long-term
mortgage with amortization, a typical household would need to save for a
long time in order to come out with a sizable downpayment of at least 40
percent of the purchase price of the property. As a result, the average age of
a ﬁrst-time home buyer in Korea is higher (from late thirties to the early for-
ties) than that in other countries where the long-term mortgage market is es-
tablished and the size of the initial downpayment is signiﬁcantly smaller.
The chapter noted that in a booming real estate market, Korean banks
198 Chang-Gyun Parkwere willing to “rollover” housing loans if the households were not willing
or able to fully repay the loan. However, in a declining real estate market,
the bullet mortgage loan structure with its short maturity structure meant
that banks would generally become more selective in granting rollovers
and renewing the loans. As a result, households may be forced to sell their
properties to repay the loans. It is likely that the selling pressure, however
weak it may be to begin with, may start to snowball, leading to depressed
property values and creating a vicious cycle by inducing further reluctance
on the part of the banks to renew the loans. Compared with more conven-
tional long-term mortgages, where loan quanta are higher, and household
income is the key determinant of debt-servicing ability, the bullet mortgage
structure seems to have a distinct disadvantage as it gives rise to boom-bust
cycles.
The interesting question is why the housing loan market in Korea did not
develop mortgages with longer tenures. It is noted in the chapter that while
bullet mortgage contracts are vulnerable to housing price shocks, they are
more robust to adverse income shocks because there is no principal repay-
ment during the loan tenure. It is argued that compared with the “conven-
tional” mortgage structure, there are likely to be fewer defaults under the
bullet mortgage structure. I am not sure if this claim is always true or if it
has been investigated in any context before. It is not necessarily the case
that households will experience greater pressure to service the housing
loan under a conventional mortgage structure because households may ei-
ther reduce their savings or alter their spending patterns to cope with the
higher monthly mortgage payments. In fact, households may reduce their
consumption and save even more to cope with contingencies when their in-
comes are not enough to service the monthly mortgage payments.
The chapter noted that in 2002, the Korean policymakers started to take
various policy measures to help smooth the rollover of maturing debts and
to introduce conventional mortgages into the housing ﬁnance market.
However, the Korean ﬁnancial institutions are involved merely as agents of
the Korean Housing Finance Corporation (KHFC). The question is why
the banks aren’t marketing long-term housing terms themselves as this ap-
pears to be a proﬁtable market segment that has found huge demand, as the
proportion of LSRP with amortization has doubled from 14.1 percent in
2003 to 28.3 percent in May 2005.
Social Welfare Eﬀects of the Increase in Household Debt
The author argues that the increase in household debt has brought about
several positive eﬀects. He cites as evidence, ﬁrst, the increased inﬂow of
credit resources into the household sector, reﬂecting eﬃciency improve-
ments in the allocation of credit resources; and second, with easier access
to credit, households were able to borrow and achieve a smoother lifetime
consumption path. The caveat, of course, is proper credit evaluation and
Consumer Credit Market in Korea since the Economic Crisis 199risk management have been undertaken by banks to ensure that the qual-
ity of the loan portfolio does not deteriorate. However, as it turned out, this
was not the case, given the particular structure of the housing loan market
in Korea.
While there are likely positive eﬀects on social welfare from the two de-
velopments described by the author, it is also important to consider the
negative eﬀects of the severe credit contraction that were to follow in 2003,
when banks (as well as credit card companies) started to curb credit supply
to the household sector. Annual growth rate of household debt dropped to
and stayed around 10 percent. I am not sure if the net eﬀects would have
turned out to be positive overall.
Overall, I commend Dr. Park for an interesting chapter that provides a
case study of some of the issues that policymakers in Asian markets have
to grapple with as they restructure the economy, particularly in the after-
math of the Asian Financial Crisis. It was a pleasure to read the chapter
and to be discussant at the NBER-EASE conference.
200 Chang-Gyun Park

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