Korea Races to Prevent Liquidity Crisis Related to Real Estate Bad Debt

Meanwhile, domestic interest rates in South Korea are projected to remain high for an extended period of time. Although the Korean real estate market has shown slight signs of recovery, it remains fragile. If this precarious situation persists, it could eventually lead to a breakdown in the capital supply chain for real estate projects, with MGCCC being the weakest link in the current circumstances. Consequently, it is inevitable that some small and medium-sized construction companies may face a liquidity crisis in a stagnant real estate market. Failure to repay loans in a timely manner by these companies could further deteriorate the financial institutions involved.

Although credit cooperatives in Korea are not officially classified as banks, their purposes and activities closely mirror those of traditional banks. MGCCC, established in the 1960s, initially focused on fostering rural economic development, collaborating with local communities, and assisting members in achieving stability in their lives. Therefore, the recent turmoil surrounding MGCCC's bad debts has come as an unexpected development. With approximately 1,295 branches nationwide, total assets amounting to 260 trillion won ($203 billion), and 21 million customers, MGCCC offers a wide range of services, including deposits, loans, and insurance.

The real estate bad debt problem engulfing MGCCC marks one of the most critical threats to South Korea's financial and credit markets since the default of Gangwon Jungdo Development, an amusement park developer, which occurred last year. The default had a severe impact on the credit market in Korea, leading to a crisis. In light of this recent crisis, South Korean financial regulators have acted swiftly to prevent the potential liquidity crisis from further escalating. Upon the initial wave of withdrawals at MGCCC in early July, the government made an announcement guaranteeing a deposit protection up to 50 million won (US$39,300) for each customer deposit. The deposit limit was predetermined by the regulatory authority, and the Korea Deposit Insurance Agency committed to reimbursing in the event of any risks.

Responding to the Bank of Korea's call, five domestic commercial banks have agreed to inject $4 billion in liquidity into MGCCC. Additionally, two state-owned banks in Korea have provided an additional $1.5 billion to address the crisis. On July 27, the Bank of Korea announced an increase in liquidity support for financial institutions to preempt any panic-induced withdrawals. The central bank also pledged to rescue non-bank financial institutions, such as MGCCC, if necessary. In coordination with other regulatory agencies, the Ministry of Interior and Security disclosed plans to conduct a special inspection of 30 MGCCC branches, with the potential recommendation for closing or merging if deemed essential. The department aims to reduce MGCCC's delinquency ratio to less than 4% by the end of the year. Some signs of improvement have been observed at MGCCC, as deposit flows into the credit cooperative have begun to stabilize.

Despite initial efforts to address the liquidity crisis, Korean debt markets continue to pose a significant threat. On July 10, the yield for three-year won-denominated corporate bonds reached its highest level since January, indicating underlying challenges. Although the yield subsequently experienced fluctuations, it has remained relatively high in recent times. 

The broader challenge faced by South Korean policymakers lies in striking a delicate balance between implementing measures to control the mounting debt crisis, rising borrowing costs, inflationary pressures, and the persistent downturn in the real estate market.