Korean Banks Brace for Asset Quality Strain as Middle East Tensions Lift Rates, Oil

Rising global oil prices and bond yields tied to turmoil in the Middle East are heightening concerns over asset quality at South Korea’s banks. Vulnerable borrowers such as the self-employed and small businesses have struggled with debt service since the COVID-19 pandemic, and higher costs from a spike in oil prices are seen further weakening companies’ ability to repay.

As of the end of February, the overall delinquency rate on won-denominated loans at the five major banks — KB, Shinhan, Hana, Woori and NH NongHyup — stood at 0.46%, according to the financial sector on Saturday. That was up 0.1 percentage point from 0.36% at the end of December, rising over two months.

By borrower type, delinquency rates were 0.35% for households, 0.11% for large companies, 0.67% for small and midsize enterprises, and 0.56% for all corporate borrowers. Compared with the end of last year, the rates rose 0.05 percentage point for households, 0.08 point for large companies, 0.17 point for SMEs and 0.15 point for all corporate borrowers.

The ratio of nonperforming loans on won-denominated lending at the five banks also increased to 0.40% at the end of February from 0.34% at the end of last year. The rise was largest for SMEs, up 0.12 percentage point, compared with 0.08 point for large companies and 0.04 point for households.

Analysts warn the indicators could deteriorate further if the oil surge and Middle East risks persist. A prolonged period of uncertainty could squeeze corporate profitability and hit financially fragile SMEs hardest.

The four major banks held 29.0567 trillion won in outstanding loans to petrochemical, airline and shipping companies as of the end of the fourth quarter of last year, the financial sector said. Within nine days of the Iran situation, the price of naphtha — a key feedstock those industries largely source from the Middle East — rose 28%, raising expectations of significant damage.

Even so, corporate lending has continued to grow since the end of last year, adding to banks’ risk exposure. As of the end of last month, corporate loans at the five major banks totaled 854.3288 trillion won, up 6.9759 trillion won from the previous month.

Looking ahead, if oil prices keep rising and supply-chain instability persists, the policy rate could shift back toward increases to curb inflation. Yields on one-year and five-year bank bonds climbed from 2.900% and 3.572% on Feb. 27, just before the Iran situation, to 3.033% and 3.907% as of March 20 — jumps of 0.133 percentage point and 0.335 point in three weeks.

Banks have responded by building reserves. Major lenders are keeping loan-loss reserve coverage ratios between 160% and as high as 220%, and are monitoring lending in real time, including by adopting a risk-adjusted return on risk-weighted assets (RoRWA) metric to manage capital adequacy.

“After the Middle East war, the uptrend in market rates and lending rates has strengthened,” a financial industry official said. “As shocks to the real economy accumulate, bad loans could visibly swell in a few years.”