Top South Korean banks face further rise in at-risk loans as rates stay high

At-risk loans made by South Korea's largest banks could further increase as high interest rates and slow economic growth prospects deepen credit risk.

Aggregate stage 2 loans at South Korea's five largest banks constituted 12.4% of gross customer loans as of Dec. 31, 2023, the highest proportion for at least a year, according to S&P Global Market Intelligence data. These loans, which carry a higher credit risk under international accounting standards, increased for the fifth consecutive quarter in the final three months of 2023.

Stage 2 loans are defined under International Financial Reporting Standards (IFRS) 9 as those with a substantially increased credit risk since initial recognition.

The banks' stage 3 loans, classified as credit-impaired, rose to 0.91% as of Dec. 31, 2023, from 0.65% a year earlier.

An executive at KB Financial Group Inc., South Korea's largest bank by assets, warned about rising credit risks during a Feb. 7 call.

"Due to continuing high interest rates, both at home and abroad, credit risk, especially in the real estate market, has expanded substantially," KB Financial CFO Jae Kwan Kim said. "After Taeyoung [Engineering & Construction] filed for a debt restructuring program in December [2023], concerns are running high of deteriorating asset quality in the real estate [project financing] market."

The announcement by Taeyoung, a medium-sized South Korean builder, raised concerns about liquidity troubles at other construction firms.

Higher interest rates have increased borrowers' debt-repayment burden, elevating credit risks. Like many central banks, the Bank of Korea (BOK) started raising rates in April 2022 to tamp inflationary pressures. It has since raised rates by more than 300 basis points.

The BOK described the country's financial system as stable overall in a December 2023 report but said major risk factors, including a change in the monetary tightening stance, could undermine financial stability. It advised banks to boost their loss-absorbing capacity by accumulating additional provisions and raising capital in anticipation of the rising credit risks.

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Asset quality in decline

The apparent decline in the South Korean banks' asset quality is in line with the BOK's own assessment of banks' asset soundness. The central bank said the substandard-or-below loan ratio, an indicator of commercial banks' asset soundness, stood at 0.30% at Sept. 30, 2023, rising continuously since the fourth quarter of 2022.

Substandard-or-below loans at commercial banks amounted to 2.3 trillion won in the third quarter of 2023, up from 1.6 trillion won a year earlier, it said. Similarly, the size of nonperforming loans reached 2.1 trillion won in the third quarter of 2023, versus 1.3 trillion won in the fourth quarter of 2022, central bank data shows.

The country's Financial Supervisory Service said in a March 29 report that as of end-January 2024 the delinquency rate on domestic banks' won-denominated loans — classified as the percentage of loans with principal or interest payment past due by at least one month — stood at 0.45%, up from 0.38% a month earlier and up from 0.31% a year ago.

The volume of resolved loans decreased by 2.7 trillion won month over month while that of newly delinquent loans grew 700 billion won between December 2023 and January 2024, the FSS said.

Loan loss reserves

The South Korean banks slowed allocating reserves for stage 3 loans in the past quarters than to their stage 2 loans, Market Intelligence data shows.

Aggregate stage 3 reserves of the banks as a proportion of stage 3 customer loans edged up to 34.83% at Dec. 31, 2023, from 34.69% in the previous quarter. The fourth-quarter 2023 reading of stage 3 reserves was significantly lower compared to the fourth quarter of 2022 when it stood at 39.81%.

Meanwhile, aggregate stage 2 reserves as a proportion of stage 2 customer loans rose to 3.28% from 3.01% in the previous quarter and 3.05% in the fourth quarter of 2022. Similar to stage 2 loans, reserves for such loans have continued to expand since at least the fourth quarter of 2022.

Shinhan Financial Group Co. Ltd. and Industrial Bank of Korea saw the largest year-over-year rise in stage 2 loans. Stage 2 loans at Shinhan rose by 2.42 percentage points to 13.42% of total customer loans as of end-2023, while those at Industrial Bank of Korea rose 1.23 percentage points to 23.16%. Hana Financial Group Inc. recorded the smallest increase at 0.17 percentage points to 12.07% of its total customer loans at the end of the 2023 fourth quarter.

Woori Financial Group Inc. demonstrated the best asset quality metrics among the five, as measured by the IFRS 9 loan data. In total, stage 1 loans at Woori stood at 91.82% of total customer loans, the highest among the five banks, while stage 2 loans accounted for 7.26% of its total customer loans, the lowest among the lot. Its stage 3 loans made up just 0.48% of total customer loans, lower than all the banks and showing a gap of 0.24 percentage points with its closest second, Shinhan.