The Impact of Housing Price Changes on Household Debt and Financial Stability
November 28, 2016
Macro Economic Analysis Division of the Economic Analysis Office
The report is designed to perform stress tests on household debt to assess financial stability in the event of external shocks that can induce defaults on the loan. If housing prices decrease, the value of household’s real assets declines, thereby undermining the borrowers’ ability to repay their mortgages. The debt-service ratio (DSR, share of disposable income to required principal and interest payments) is employed to assess this ability. Two scenarios relating to housing prices’ fall are introduced in the stress tests. Housing prices decline “across the nation” in the first scenario, and the prices decrease “at a different rate between the Seoul metropolitan area and the rest of the country” in the second.
The findings of this stress-testing show that if housing prices fall by 20%, the first, second and third highest-risk groups of indebted households would incur losses of up to KRW 20.8 trillion, KRW 15.2 trillion, and KRW 28.8 trillion, respectively, to financial institutions. With respect to the impact of the financial losses, the BIS capital adequacy ratio of financial institutions would drop for each high-risk group by 1.4%p, 1.0%p, and 2.0%p, respectively. Moreover, the BIS ratio of commercial banks would drop 1.9%p, and that of local and special banks would both fall by 2.0%p under the scenario of a maximum financial loss of KRW 28.8 trillion. However, when simulating multiple shocks with drops in housing prices and simultaneous insolvencies of business debts, the BIS ratio of most financial institutions would exceed the first class standard of 10%, but that of special banks would be 9.6%, below the first class threshold.
Therefore, the economic shock of a 20% drop in housing prices does not cause a significant risk to financial system all other things being equal, but the stability of the system would not be guaranteed if corporate insolvency occurs coupled with the above shock.