Financial authorities are considering an increase in the risk weight for mortgage loans, which could heighten the capital management burden for banks. Following a rise in the risk weight floor for home loans this year, the lower limit for calculating risk-weighted assets (RWA) is also set to increase next year. If additional regulations are implemented, banks may face challenges in maintaining their existing capital ratios while expanding mortgage lending.
According to the financial sector on October 12, Lee Ok-yeon, chairman of the Financial Services Commission, stated during a National Assembly audit on October 8 that he would review the possibility of raising the risk weight for mortgage loans based on market conditions. Since January of this year, the lower limit for the risk weight on new mortgage loans for banks using the internal ratings-based approach has been raised from 15% to 20%.
Risk weight reflects the level of risk associated with loans and investment assets. An increase in risk weight means that even for the same loan amount, the risk-weighted assets (RWA) will rise. If the bank's equity remains unchanged, the capital ratio under the Basel III framework will decrease, necessitating either an increase in capital or a slowdown in the growth of risk-weighted assets.
Next year, the output floor, which sets a minimum for RWA calculated using internal models, will also be raised. This regulation prevents the RWA calculated by internal models from falling below a certain percentage of the RWA calculated using standard methods, with the applicable ratio increasing from 65% this year to 70% next year, and 72.5% by 2028. Banks whose internally calculated RWA falls below this new threshold may face additional burdens in managing their capital ratios.
Separately, authorities are also considering adding high debt service ratio (DSR) and high loan-to-value (LTV) loans to the category of high-risk mortgage loans, as well as introducing a system buffer capital for systemic risks in the household sector. The timing and implementation of the increase in mortgage loan risk weights and these measures have not yet been finalized.
The risk-weighted assets of banks are already on the rise. In the second quarter of this year, the RWA of domestic banks increased by 42.6 trillion won (1.7%) compared to the previous quarter. During the same period, common equity tier 1 capital rose by 8.8 trillion won (2.2%). The growth rate of common equity tier 1 capital outpaced that of RWA, resulting in an increase in the common equity tier 1 capital ratio to 13.62% and the total capital ratio to 15.77%, up 0.12 percentage points and 0.03 percentage points, respectively.
While the current capital ratios have improved, an increase in RWA due to additional regulations may necessitate securing more capital to maintain existing ratios. The impact on individual banks will vary based on the size of their mortgage loans, the applicable risk weights, and their capital capacity. Banks with limited capital capacity may face greater pressure to adjust the pace of mortgage loan growth and their loan composition.
Capital management is also a factor to consider in the authorities' push for expanding productive finance. Corporate loans will also vary in capital burden depending on the borrower's creditworthiness and the presence of collateral or guarantees, leading banks to potentially focus on increasing loans with lower capital burdens.
A financial sector official noted, 'As capital regulations tighten, banks will inevitably consider capital burdens in the process of expanding corporate loans,' adding that 'productive finance is likely to be selectively focused on sound companies and guaranteed loans.'
* This article has been translated by AI.
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