On March 9, 2023, depositors pulled $42 billion from Silicon Valley Bank in a single day. The unprecedented digital bank run forced the lender to shut its doors the next day. It came after the Federal Reserve had raised its benchmark rate from near zero to the mid-4% range in the span of a year. As rates climbed, the prices of long-term Treasury bonds SVB had bought fell, leaving the bank with massive unrealized losses. The shock from rate increases builds gradually, but the bill arrives all at once.
The Bank of Korea raised its benchmark rate by 0.25 percentage point in each of July and August this year. The rate jumped from 2.5% to 3.0%. Inflationary pressure from high oil prices stemming from the Middle East, a boom in artificial intelligence and semiconductors, and a recovery in domestic demand lie behind the tightening. Members of the Monetary Policy Board see the benchmark rate at 3.25% six months from now, while the market expects 3.25% to 3.50%. The bond market has already priced in much of any further increase. Rates have been priced in, but the cost borrowers will pay has not.
The books of households and companies are already sounding alarms. Household loans swelled to 2,019 trillion won in the second quarter of this year from 1,979 trillion won at the end of last year, while corporate loans grew to 1,961 trillion won from 1,903 trillion won. The delinquency rate at banks also rose to 0.63% from 0.50%. The delinquency rate on household loans to vulnerable borrowers stands at 10.4%, 26 times the overall rate. For vulnerable self-employed business owners, the rate is 12.71%, more than six times that of all self-employed borrowers. The delinquency rate on corporate loans from non-bank lenders is 6.28%, nine times the level at banks. The shock from rates bores into the weakest links first.
Rates have been priced in, but the pain starts now. The success or failure of monetary policy is not decided by market interest rates alone. Tightening succeeds only when households' ability to repay, companies' capacity to invest and the resilience of the financial system all hold up together. Price stability is a goal that cannot be abandoned. Neither can preserving the engines of growth. Even if the direction of tightening is right, its pace, intensity and side effects must be weighed separately.
A one-percentage-point rise in rates increases household interest payments by roughly 13.4 trillion won a year, or an average of 680,000 won per borrower. For borrowers whose debt service ratio has reached its limit, even a small increase in rates becomes the trigger for default. As delinquencies rise, financial institutions raise lending hurdles to protect their soundness. Funding dries up even for healthy households and companies. Bad debt brings a credit crunch, and the credit crunch in turn breeds more bad debt. The "financial accelerator" starts to spin.
Industry is no exception. National strategic industries such as AI, semiconductors and defense require large upfront investment and long periods of research and development. When rates rise, the cost of raising capital goes up and the net present value of investment projects falls. Capital spending and R&D are the first things pushed back. Large companies can hold out on their accumulated cash, but small and mid-sized firms and venture companies take an immediate hit. Tightening meant to tame inflation must not cool the growth engines of the future as well.
There are three things the government and the monetary authorities must do without delay.
First, preemptive risk management that accounts for policy lags. The Bank of Korea must analyze in detail, by income bracket, industry and type of lender, how further rate increases would affect the interest burden and delinquency rates of households, the self-employed and small and mid-sized businesses. Potential losses among vulnerable borrowers must be examined through stress tests that incorporate even extreme risk scenarios.
Second, mechanisms for a soft landing on bad debt among vulnerable borrowers must be put to work. The Ministry of Economy and Finance, the Financial Services Commission and the Financial Supervisory Service must weave debt restructuring, maturity extensions, improvements to repayment structures and policy finance into a single package, and offer tailored measures according to each borrower's ability to repay. Neither indiscriminate debt forgiveness nor irresponsible neglect of bad debt will do.
Third, production and investment in the nation's core industries must be protected at all costs. What is needed is a finely calibrated policy mix aimed at both price stability and expanding growth potential. Selective credit support tools such as the Bank of Korea's intermediated lending support facility must be organically linked with policy finance, guarantees and long-term patient capital to underpin capital spending and R&D in future growth and strategic industries such as AI and semiconductors.
Rates are a tool for taming inflation, but they must not break growth. A crisis erupts not on the day rates are raised but on the day a bill arrives that cannot be paid. Shoring up the weak links in the economy and protecting the engines of growth before that bill comes — that is what the government and the monetary authorities must do now.