Vulnerable household lending slows consumption in Korea

A new BIS working paper, using Korean consumer credit data from 2017 to 2023, identifies 'zombie borrowers' (DSR > 50% but not delinquent) and delinquent borrowers (overdue by 30 days).

It finds that zombie borrowers, often asset-rich with secured loans, tend to persist in their status and rarely transition to delinquency.

A key finding is the continued 'evergreening' of loans to these zombie households, primarily by non-bank financial institutions.

Zombie borrowers experience significantly slower consumption growth over three years compared to normal borrowers.

Delinquent borrowers also see an initial consumption slowdown, but their growth recovers within three years, potentially due to government support.

When interest rates increase, vulnerable borrowers' consumption is more negatively affected, highlighting their sensitivity to higher debt service burdens.

An increased share of zombie borrowers in a city leads to a notable decline in that city's consumption growth, especially among low-income and young borrowers, underscoring the aggregate impact of household vulnerability.

Korea has faced high household indebtedness since the mid-2010s, despite macroprudential measures like LTV and DSTI restrictions.

This persistent debt has often coincided with weak consumption and GDP growth, highlighting individual borrower vulnerability.

The paper suggests policymakers focus on zombie households' consumption dynamics.

Stringent regulatory limits on the debt service ratio are crucial to prevent normal households from becoming zombies.

Given zombie borrowers' reliance on non-bank financial institutions for continued borrowing, comprehensive debt service limits applied to all financial institutions are warranted.

Debt relief programs for deeply zombie, young, and low-income households could boost consumption, but moral hazard requires careful consideration.