South Korea to tighten loan standards as household debts grow fast

South Korea will encourage banks to tighten loan standards as household debts grew at a faster pace than income, but the tighter standards may have little effect amid no change in record-low policy rate and looser mortgage-financing regulations.

The country's finance ministry, central bank and financial regulator announced a package of measures Wednesday to control the rapidly-rising household debts, which reached almost 1,100 trillion won (some 1 trillion U.S. dollars).

Under the package, banks will be induced to lend money based on the debt-servicing capability of borrowers, not on the value of collateral or assets. It will lead borrowers in higher-income bracket to get larger loans at an easier way.

Banks will induce borrowers to repay both principal and interest to scale down household debts. The grace period for loans will be shortened to less than a year from 3-5 years, and the fixed-rate loans will be favored by banks.

The package was aimed at prompting households to repay debts and borrow money within the scope of repaying capability as household debts grew twice faster than income.

When Organization for Economic Cooperation and Development ( OECD) revised down South Korea's 2015 growth outlook by 0.8 percentage points to 3 percent in June, the global agency cited a surge in household debts as one of reasons for the downward revision.

The surging debts stemmed mainly from the record-low interest rates and the easing of regulations on mortgage financing. Mortgage loans surged 11.3 percent in the first quarter of this year after jumping 10.2 percent in 2014, much higher than a 3.4 percent growth in 2013.

Bank of Korea (BOK) has cut its benchmark interest rate by a percentage point in the past year to an all-time low of 1.5 percent. Financial Services Commission (FSC) eased the loan-to- value (LTV) and debt-to-income (DTI) ratios since August last year.

Helped by record-low lending rates and easier mortgage standards, households rushed to purchase homes since 2014 with the borrowed money, making great contributions to the surging home- backed loans.

With no change in interest rates and the mortgage-financing regulations, the tighter loan standards alone could have little effect on the fast-growing household debts.

The tighter standards from banks may drive borrowers in the low- income bracket to ask loans from unauthorized lenders, which tend to demand a super-high interest rate of at least 30-40 percent.