Discussions about establishing a "bad bank" to adjust and alleviate the debts of self-employed individuals that occurred during the COVID-19 pandemic are gaining momentum. After the inauguration of the Lee Jae-myung administration, financial authorities immediately began preparations for the establishment of the bad bank. Since President Lee directly mentioned the necessity of a bad bank, it seems that the policy will be promoted at a fast pace. However, the expected effects are unclear. A review of past academic research shows that one-time debt adjustments have limited effectiveness in terms of the economic self-sufficiency of self-employed individuals.
According to the financial sector on the 11th, the Financial Services Commission is preparing the establishment of a bad bank for the adjustment and alleviation of COVID-19 loans at the practical level. On the 5th, the Financial Services Commission announced a change to the regulations on individual debtor protection. The proposed changes to the regulations include allowing non-profit corporations to purchase debts. This makes it possible for a model of a bad bank, like the Jubilee Bank that President Lee pursued during his tenure as mayor of Seongnam, where civic groups can buy and burn non-performing loans. At the same time, the Financial Services Commission has begun to ascertain the scale of long-term small overdue loans related to COVID-19. This is a procedure to identify the scale of debts that need adjustment and alleviation before the establishment of the bad bank.
The adjustment and alleviation of COVID-19 loans were promises made by President Lee during his campaign and in TV debates. In a TV debate on the 18th of last month, President Lee said, "Even if the state assumes the liabilities, the government should have borne the costs of overcoming COVID-19 like other countries." The Democratic Party of Korea's campaign book released afterward also included extraordinary measures for the adjustment and alleviation of COVID-19 loan debts and plans for the establishment of a bad bank for the disposal of long-term small overdue loans. The campaign book explained that it is aimed at "relieving the burdens of households and small businesses and revitalizing the domestic economy." President Lee believes that reducing the debt burden of self-employed individuals will bring vitality to the domestic economy.
◇ Past research results show limited effectiveness of debt adjustment for self-employed individuals
However, the research results thus far do not align with President Lee's expectations. According to a paper by Professors Kim Seong-sook of Keimyung University and Jeong Woon-young of Sungkyunkwan University published in the Journal of the Korean Financial Planning Association in 2022, despite an increase in the individual debt adjustment system during the COVID-19 pandemic, self-employed individuals had a 1.6 times higher probability of failing to adjust their debts compared to employees. Being eligible for debt adjustment means that while some principal and interest can be waived, the remaining debt must still be repaid, which means that many self-employed individuals fail to keep up with these repayments and drop out of the debt adjustment program.
The effectiveness of debt adjustment for self-employed individuals showed limitations even before the COVID-19 pandemic. A report published in 2014 by Researcher Oh Yun-hae of the Korea Development Institute (KDI) included research findings that the success rate of personal workouts for self-employed individuals was at the level of 60% compared to employees. This report also suggests a high likelihood of failure in debt adjustment for self-employed individuals. According to the expected effects of the bad bank, self-employed individuals with reduced debt burdens should regain their economic capabilities, but previous studies point out that even self-employed individuals who received the benefits of debt adjustment often fail to achieve self-sufficiency.
The fact that there are no foreign precedents for bad banks focused on individual debt adjustment also raises doubts about the policy's effectiveness. Foreign bad banks are primarily utilized to dispose of large-scale non-performing assets resulting from corporate loans to enhance the soundness of financial firms. In contrast, there have been no successful cases of introducing a bad bank for debt alleviation of specific groups, as envisioned by the Lee Jae-myung administration.
Experts have pointed out that a bad bank is not a fundamental solution to the problem of non-performing debts among self-employed individuals. KDI Researcher Kim Mi-ru noted, "Even if a bad bank is established, continuously accepting the debts of self-employed individuals can lead to adverse effects as a moral hazard." Researcher Kim stated, "Since the fundamental cause of the self-employed debt problem lies in the oversaturation of self-employment, institutional measures are needed to convert debt adjustment candidates into wage earners," and advised that "if a bad bank is necessary, it should operate in a limited manner in this process."
☞ What is a bad bank?
A specialized institution that takes over and organizes non-performing assets of financial firms. The first bad bank model was introduced by American Savings Bank in 1988. Since bad banks specialize in the disposal of non-performing assets, existing financial firms can hold only sound assets, thereby improving their financial soundness. In Korea, the Korea Asset Management Corporation (KAMCO) serves as the bad bank.