S.Korea's tightening rule on household debts to drive up interest rates

South Korea's financial watchdog said Wednesday it will tighten rules on household debts as excessively rising debts are feared to hamper economic growth.

According to the statement by the Financial Services Commission (FSC), local banks will be required to raise the proportion of fixed-rate loans to 30 percent from the current 5 percent by 2016.

Floating-rate loans accounted for 95 percent of home-backed loans in the country as of the end of 2009, far higher than 10 percent in the U.S., according to the statement. The loans with floating rate, the interest payments of which decrease in accordance with the central bank's accommodative monetary policy, have been blamed as one of the culprits for surging household debts in South Korea.

The Bank of Korea (BOK) cut its policy rate to a record-low of 2 percent following the global financial crisis. The nation's households rushed to borrow loans to enjoy the record-low borrowing costs, sending the household credit to a record 801.4 trillion won (745 billion U.S. dollars) as of the end of March.

An increase in fixed-rate loans will reduce risks for default in household debts as the BOK is expected to maintain its monetary tightening stance for the time being. The BOK board members decided unanimously to raise the key interest rate to 3.25 percent at the June rate-setting meeting.

Market watchers, however, warned that rising fixed-rate loans may strengthen demand for paying positions in the interest rate swap (IRS) market, driving local bond yields higher in the end. The yield on the three-year treasury notes jumped 5 basis points to 3.77 percent, and the return on the benchmark five-year government bonds gained 4 basis points to close at 4.01 percent. Local banks have massively built up their IRS receiving positions to hedge for the potential risk of rate decreases. The interest margin of local banks, which extend loans with floating rates, contracts when the market rates were lower, so domestic banks locked in profits in advance by receiving the fixed-rate interests through the IRS market.

"Reducing floating-rate loans may trigger unwinding of the existing IRS receiving positions. The unwinding will boost the IRS rate higher, leading to an increase in local bond yields," a bond analyst at local brokerage told Xinhua.

"Rising fixed-rate loans will increase IRS pay positions among local banks, pressuring local bond yields to go higher," said a local bond dealer at a foreign bank, who asked to be unidentified. According to a separate statement, the FSC plans to encourage banks with a capital adequacy ratio of at least 10 percent to issue covered bonds.

Covered bonds have a form of asset-backed securities (ABS) with lower yields and longer maturities, backed by assets such as mortgage loans. Once the covered bonds, which have longer maturities, are actively sold by local banks as planned, local bond yields will likely be lifted mainly in longer tenor amid growing supply of the bonds, market watchers here said.

"An increasing supply of covered bonds will push the local bond yields with longer maturities to go higher," the bond analyst at local brokerage said.

The analyst, however, forecast that growing issue of covered bonds will activate the local bond market as the ten-year government bonds are the only target for long-term investors such as insurers in the country.

Meanwhile, the tightening rules on the loan-to-deposit ratio of local banks may add upward pressures on the borrowing costs in the local funding market, experts said. Domestic banks will be asked to lower their loan-to-deposit below the maximum 100 percent level by June 2012. The financial watchdog originally planned to cut the ratio by the end of 2013.

The loan-to-deposit ratio gauges the percentage of loans against deposits. The higher reading indicates a bank extended loans more than it can raise funds. Local banks should choose between reducing their lending and increasing their deposits when they want the ratio down.

"A decrease in lending by local banks will lead local firms to pay higher interests when they need to finance operations. Banks' efforts to increase their deposits will also boost the deposit rate higher, resulting in higher borrowing costs," the bond analyst at local brokerage said.

Editor: yan

English.news.cn   2011-06-29 23:52:11 FeedbackPrintRSS
By Yoo Seungki

SEOUL, June 29 (Xinhua)