South Korea: Household Debt: Financing Without Banks

British Embassy Seoul

July 2012

Summary

“Accommodation for rent: no rent required” – a counterintuitive statement. Yet one which comes naturally to the majority of Koreans who rely on the country’s unique Jeonse system, in which the landlord borrows from the tenant, with the house as collateral. In essence, a repurchase agreement (Repo). This has traditionally enabled direct debt financing which by-passes Korea’s imperfect banking sector. Yet as household debt levels continue to climb, what does this unique form of financing mean for the sustainability of the Korean housing market?

Detail

Korea’s household debt-to-GDP ratio is now at a record high of 74.2% – the highest in Asia, after Japan. Although the overall pace of household credit growth since 2005 appears to be a manageable risk, the quality of the household debt has deteriorated in recent years. Since 2010, a larger share of household loans have borrowed from the non-banking sector (i.e. mutual saving banks, credit card company, etc.) at high interest rates. Loans from the non-banking sectors are higher risk in nature given the weaker credit profile of the borrowers. The non-banking sectors now hold 50% of the country’s household loans, increasing from 45.8% in 2008. This is mainly due to regulators’ tightening on core banks’ retail lending – forcing households with weak credit ratings to turn to the non-banking sector to borrow.

2. One of the major factors in the rise of household debt has been Korea’s unique mortgage-loan system called Jeonse, where tenants pay a large lump-sum rental deposit at a certain ratio of the property’s market value upfront (now averages about 60% of the property value), and the landlord will return the entire deposit at the end of the lease, which is typically two years. In the interim period, there are rarely any cash payments in either direction. This system traditionally had the advantage of enabling financial intermediation while by-passing Korea’s under-developed banking sector.

But as Jeonse prices continue to rise, an increasing number of tenants are now forced to turn to bank loans to secure the large up-front deposits needed to rent – yet alone buy – accommodation. The nationwide rental prices (i.e. Jeonse and monthly rent) jumped 26.3% since 2009. This contributes to household debt, which are already at the record high. Jeonse prices continue to soar while property price growth has stalled compared to neighboring countries (increase rate since 2009: Korea 10.8%, Hong Kong 70%,  Singapore 26.6%, Taiwan 20).

Rising Jeonse prices also play a part in dampening consumption given Korea’s low home ownership (53%). In a regular housing market, economists have suggested that higher rental cost should not hamper consumption in aggregate, as it is just a wealth transfer from the tenants to the landlords. Yet, in Korea’s Jeonse system, landlords are not free to spend the rental deposits they receive, rather they should sit on the deposits earning interest income only. As a result, higher rental prices rarely benefit the landlords in proportion to the rental price increase.

5. Falling property prices and rising Jeonse prices is a counter-intuitive mix – one would expect both moving in a similar direction, ceteris paribus. Such divergence stems from the loss of buyers’ confidence in the property market due to the government’s stringent anti-speculative measures to prevent a property bubble in 2007. The good news is that Korea’s housing market – considered by many to be inflated in price – seems to heading for a soft landing, but the bad news in the interim is that this is increasing household debt and weakening consumption.

Disclaimer

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