High-Interest Loan Rates: Seeking a Path to Shared Prosperity

The recent focus in the financial sector has been the criticism of banks posting record-high profits based on interest income, along with concerns over household debt exceeding 1,000 trillion won and the broader economic downturn, which together have made rising loan interest burdens for households and businesses a major strain on the public.

The criticism directed at the financial sector likely also reflects its own failure to act proactively in solidarity with the public, the key participants in the economy. The financial sector may offer various rebuttals, but in the current high-interest-rate environment, such arguments are unlikely to resonate immediately with ordinary citizens relying on loans.

Financial institutions are organizations that must generate profits, and among the capabilities expected of CEOs and leaders up to now, profit generation has been one of the most important, which has only reinforced this pattern of behavior. In a market economy, there is generally no objection to earning profits. However, in a macroeconomic crisis, wisdom is needed so that the economic community can overcome difficulties together.

The President strongly criticized banks’ interest-based business, even using the expression that they were acting as “slaves of the banks,” and condemned the excess profits of the banking sector. The opposition party also suggested that a “Korean-style windfall tax” should be considered. Both the government and the opposition are actively voicing resentment over banks’ excess earnings and the view that they should share in the public’s economic pain.

To promote coexistence with households and businesses burdened by high loan rates, and to curb a sharp increase in new lending, one option is to apply differentiated interest rates to existing borrowers and new borrowers. In the banking sector, base rates differ depending on when a loan was issued. At a time when interest rates have risen to more than double their previous base levels, the burden of loan interest means that households and businesses must bear hardships that have effectively doubled.

In particular, when the time comes for amortized repayment, under which both principal and interest must be repaid after a certain period, the burden of loan interest becomes even heavier. It is natural for loan rates to reflect funding costs in the market. However, the rates offered to customers also include a kind of margin.

Financial institutions are structured to continue generating profits so long as customers do not go bankrupt or become uncollectible. Preparing loan-loss provisions and other reserves for cases where recovery may be difficult is part of the nature of financial institutions. A situation in which citizens can avoid bankruptcy or default is, in fact, the best policy outcome for financial institutions as well.

In light of the current high-interest-rate environment, I would like to suggest measures that could proactively address these concerns by lowering loan rates. First, differentiated lending rates should be applied to existing borrowers and new borrowers. This reflects the fact that the funding cost at the time of an existing loan differs from the lending rate at the time a new loan is made. New loans can be managed in consideration of the market’s high funding costs, while existing loans can be handled in a way that eases the burden on households and businesses or encourages repayment, thereby creating mutual gains.

First, one option is to temporarily defer amortized repayment, or to operate a partial principal-and-interest repayment system that is now rarely used, in order to reduce the burden on the public. Until the high-interest-rate environment improves, temporary deferment or partial principal-and-interest repayment could ease the burden on borrowers while also reducing the outstanding volume of existing loans.

Second, when borrowers enter the stage of repaying both principal and interest, a lower interest rate could be applied so that the public’s repayment burden declines and banks’ profits are also reduced, creating a mutually beneficial arrangement. At the point of principal-and-interest repayment, existing prepayment penalties could also be waived, and loan balances could be reduced through refinancing under the same conditions or by applying lower interest rates.

Third, for loan extensions and repayments of existing loans, a differentiated approach based on loan size could be adopted. Depending on the scale of household and business loans, such as loans under 100 million won or under 500 million won, lower interest rates could be applied more aggressively to relatively smaller loans so that many ordinary citizens benefit.

Fourth, in areas with social needs that require policy support—such as young people, newlyweds, and the elderly—financial institutions could operate more proactively and in ways suited to their own characteristics, thereby allowing the financial sector’s intermediation function to work more smoothly.

In the economic crisis caused by high interest rates, a path of shared prosperity in which banks share their excess profits with the public could, from a macroeconomic perspective, help households and businesses overcome their marginal circumstances and provide a foundation for reviving the economy. If each financial institution responds proactively with its own know-how and autonomous measures, it may be reborn as an institution loved by the public.

Heonseok Lee, Director of External Relations, Center for Free Enterprise (CFE) / Director, Korea International Economics Association

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Original title: 고금리 대출이자, 상생의 길을 찾아야

Author: Heon-seok Lee

Date: 2023-11-13

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=press&idx=26132