Korean banks are expected to tighten credit standards for home loans starting from February next year, amid concerns over the country’s record-high household debt.
The Korean Association of Lenders and the watchdog Financial Services Commission jointly announced new lending guidelines Monday, which will be introduced in Seoul in February and the rest of the country in May.
The industry-led guidelines call for lenders to require new borrowers to prove their income and repayment ability, a departure from current practice that puts more weight on collateral. It also entails a drastic reduction in loan grace periods.
To guard against credit delinquencies, lenders have also been asked to use the debt service ratio to check a borrower’s credit risk. Billed as a more comprehensive measure than the debt to income ratio currently in use for new mortgage issuance in the Seoul area, the DSR measures a borrower’s cash available after servicing his or her total debt obligations — including banking, car financing, credit card and other financial institutions.
“The guidelines are not aimed at controlling the aggregate size of new loans,” Sohn Byung-doo, director general at the FSC, said at a press conference. “This is about banks managing credit risks more proactively.”
Devised by banks themselves, the guidelines are not mandatory.
The tightening in loan screening follows a series of steps taken by the financial authorities earlier this year to tackle the growth of household credit in Korea.
With the U.S. expected to start raising interest rates this week, concerns are growing that the high level of household debt could turn perilous for the economy.
According to the Bank of Korea, household debt in the third quarter stood at 1.16 quadrillion won ($978 billion), the highest since it began compiling the data in 2002. It is about 84 percent of gross domestic product in 2014, growing at a faster pace than the GDP.
In March, the financial authorities ran a 40-trillion won program in March to help borrowers convert their short-term floating-rate mortgages into long-term fixed rate ones to prepare borrowers for a potential rate hike.
Korea’s key interest rate stands at a record low of 1.5 percent, unchanged since June and down 1 percentage point from a year ago.
With the U.S. Federal Reserve widely expected to hike its borrowing rates, experts say interest rates in Korea will eventually rise in tandem with the U.S. level, with a time lag.
Monday’s guidelines also encourage lenders to finalize a loan after the interest-rate stress test that gauges the expected impact of interest rate hikes on borrowers.