South Korea reviews debt workout reforms

The policy backdrop is increasingly urgent. The Korea Asset Management Corp., which runs the New Leap Fund, had written off 2.2583 trillion won of long-term overdue debt by end-August, wiping out obligations for about 269,000 debtors. The fund has purchased 11.8262 trillion won of delinquent claims through August, underscoring how much stressed debt remains on balance sheets even before any new reforms are introduced.

Authorities are now looking beyond one-time write-offs and toward a system that gives borrowers more of a say in restructuring terms, while also trying to avoid a cycle in which forgiven debtors are pushed back into borrowing just to survive. Officials have also discussed measures to support debtors after forgiveness so they can resume work and business activity, a recognition that debt relief only matters economically if it restores earning power rather than simply defers distress.

That matters for investors because the stress is concentrated in sectors that are already under strain from high rates and weak demand. The Bank of Korea said construction-sector self-employed borrowers had the highest delinquency rate in the second quarter at 4.86%, up sharply from 3.31% in the fourth quarter of 2024 and 5.00% in the first quarter of this year. Hospitality and food services, wholesale and retail, manufacturing and real estate also showed elevated arrears, pointing to lingering pressure on small-business credit quality.

A report from the Korea Institute of Finance suggests the problem is not yet a systemwide banking crisis, but rather a growing pocket of risk in vulnerable industries. It said overall corporate profitability and debt-servicing ability have improved this year, but gains are concentrated in semiconductor, AI-related and transport-equipment sectors, while wholesale and construction-related weakness persists. It also warned that real estate and wholesale borrowers account for more than 60% of corporate lending in the financial sector, much of it through nonbank and small-business channels that charge higher rates and are more exposed if inflation and tight financial conditions last longer.

For policymakers, the bull case is that more aggressive restructuring can reduce social welfare costs, speed the exit of nonviable firms and let viable borrowers restart. The bear case is moral hazard: easier forgiveness could encourage overborrowing and weaken repayment discipline if not paired with tighter screening and post-restructuring support. The government appears to be betting that the economic gains from faster balance-sheet repair outweigh that risk.

For banks and nonbanks, the immediate issue is not a wave of losses at the largest institutions, but the slow realization that credit pain may need to be managed administratively rather than through market forces alone. That could keep reported delinquency ratios from worsening abruptly, but it may also pressure lenders to absorb more restructuring costs and adjust underwriting standards in sectors such as construction, hospitality and retail.

The next test will be whether the FSC’s revisions broaden access to workouts without encouraging fresh leverage. If successful, the policy could help clean up legacy debt from the pandemic and cooling property cycle. If it goes too far, lenders may respond by tightening credit in already fragile sectors, delaying the very restructuring the government wants to accelerate.