Lee Jae-myung, the Democratic Party of Korea's presidential candidate, is reportedly reviewing a pledge to lower the legal maximum interest rate from the current 20% to 15%. While this aims to reduce the financial burden of interest on consumers, there are concerns that those with low credit scores who take loans at 15% to 20% from secondary financial institutions may no longer be able to secure loans.
Those with low credit scores pushed out of the institutional framework have no choice but to rely on government policy loans such as Sunshine Loan and New Hope Seed. There are suggestions that the financial burden and social costs resulting from the expansion of policy loans will outweigh the interest reduction effects from lowering the maximum interest rate.
◇ "20% of card loan users will not be able to secure loans"
If the maximum interest rate is lowered, the number of individuals with low credit scores who cannot even access card loans, a common financial resource for the public, could increase.
On the 15th, looking at the card loan interest rates of eight major card companies (Lotte, BC, Samsung, Shinhan, Woori, Hana, Hyundai, and KB Kookmin Card) from last March by credit score, five of them, excluding BC, Hana, and KB Kookmin Card, applied an operational price (loan interest rate) exceeding an average of 15% for customers in the credit score range of 701 to 800 points. For those with scores below 700, all eight card companies have set the card loan rates at a minimum of 16.5% and up to 19.9%. Therefore, consumers with credit scores below 700 are increasingly at risk of being unable to secure loans.
The card industry estimates that 20% of card loan users will be unable to obtain loans. Considering that there were about 2.6 million card loan users in the first half of 2020, approximately 520,000 people will not be able to access card loans. Based on the card loan usage figures from last February, it was reported that 47.3% of members using card loans across eight card companies had interest rates of 16% or higher, while the proportion of members in the 18% to 20% interest rate range was about 27.6%.
Card loan interest is composed of costs and margins. The costs include the funding expense incurred by card companies to provide loans, provisions for arrears, business expenses, and various other expenses. Ultimately, card companies must reduce their margin rate (target profit margin) in order to offer loans within the legal maximum interest rate, and once the margin reaches '0', there will be no incentive to provide loans.
If the procurement interest rate, one of the costs of card loans, increases, the number of customers unable to secure loans will also increase. Card companies raise funds by issuing bonds (financial bonds) and lending them out with a margin added. The interest rate that card companies incur when issuing bonds is commonly referred to as the procurement interest rate. However, during times of benchmark interest rate increases, procurement rates can rise by more than double. Thus, if the benchmark interest rate rises by 1 percentage point, it effectively eliminates 2 percentage points of loan capacity.
◇ "Lending in the credit loan sector will disappear"
Not only card loans but also credit loans in the secondary financial sector are likely to decrease significantly. A financial industry official noted, "If the maximum interest rate is lowered to 15%, there is a possibility that credit loans will not be issued in the entire secondary financial sector," adding, "It is expected that collateral loans will increase instead of credit loans."
According to a report released by the Korea Development Institute (KDI) in 2022, if the current legal maximum interest rate, which is 20%, is lowered by 2 percentage points, approximately 659,000 financial consumers seeking credit loans from card, capital, and savings banks will be unable to secure loans from the secondary financial sector. The total amount of loans held by these consumers was approximately 33.2 trillion won as of 2021. If the legal maximum interest rate is lowered by 4 percentage points, it is projected that 1.08 million people (55.3 trillion won) will fall outside the institutional framework.
Low credit individuals unable to secure loans from the secondary financial sector will ultimately have to borrow from the tertiary financial sector, such as lending companies. However, the lending industry assesses that lowering the maximum interest rate will not only fail to accommodate loan demand but also put the industry at risk of extinction. They argue that the cost of lending has already exceeded 15%, meaning charging the maximum interest would lead to losses.
The lending industry is already experiencing reduced size due to several rounds of maximum interest rate reductions. In 2012, the number of lending users was 2.5 million when the maximum interest rate was 39%, but it had decreased to about 980,000 by 2022 when the maximum interest rate had fallen to 20%. Sanwa Lending, which had the largest loan volume in 2017, halted new loans in 2019. Other companies that had been in the top ten, including Afro Financial, Joy Credit, Mizusarang, and Welcome Credit Line, have also stopped issuing new loans or withdrawn from the lending business.
Financial consumers who can no longer use lending services now rely on government loans that offer low-interest options for low-credit individuals. According to a report from the Korea Financial Research Institute made public last December, after the maximum interest rate was lowered to 24% in 2018, some of the consumers who had been utilizing loans exceeding that rate, amounting to 99,000 individuals, are now using policy financial services. It is estimated that 261,000 individuals have reduced their financial transactions, while about 50,000 have turned to illegal private lending.
To prevent low-credit individuals from turning to illegal private lending due to the reduction in maximum interest rates, there is an increasing necessity for the government to increase loan provisions. This year, the government plans to increase the amount of policy microfinance supply to a record high of 11.8 trillion won. Thus, a reduction in the maximum interest rate aimed at decreasing interest burdens for financial consumers ultimately leads to an expansion of the government's financial burden.
In the secondary financial sector, there have been long-standing calls to allow the maximum interest rate to be adjusted in line with market rates, to increase or decrease as the situation demands. A financial sector official remarked, "Raising the legal maximum interest rate is normal; however, lowering it is hard to understand," adding, "The maximum interest rate should fluctuate in line with actual interest levels, and it doesn’t make sense that once it's set by politics, it stays that way."