Last week, alarming reports surfaced regarding a significant increase in non-performing loans associated with real estate projects in South KoreaThis revelation ignited widespread panic among the citizens, resulting in long lines at banks as people rushed to withdraw their savings.

In a year marked by rising interest rates following the U.Smonetary policy and a subsequent drop in real estate prices, South Korea has witnessed a string of unfortunate eventsThe real estate collapse and scandals involving rental fraud led to tragic outcomes including suicides of victims, one of whom was former Korean shot put champion Park Hee-soon, who represented the nation at the 2010 Guangzhou Asian Games and the 2015 Wuhan Asian ChampionshipsThis wave of tragedies finally prompted the government to take notice.

On April 18, President Yoon Suk-yeol publicly addressed the issue during a cabinet meeting, labeling the rampant rental scams as targeting vulnerable groups and ordering the cessation of property auctions tied to these fraudulent cases

While the government seemed to stabilize the situation through administrative orders, the overall economic outlook for South Korea remained grim with ongoing trade deficits and a tense financial environment.

How dire is the economic situation? Consider Samsung Electronics, a pillar of the South Korean economy, which reported a staggering 95.7% drop in profits in the second quarter of this yearYet, in the upper echelons of South Korean business, this disappointing figure was viewed as a positive surprise since it exceeded expectations.

Given these developments, the apprehension among South Koreans is palpable; it’s a climate where every rustling leaf and distant sound triggers alarm.

The run on South Korea's credit cooperatives was an unsurprising consequence of these tensions.

The MG Community Credit Cooperatives (MGCCC) operates as a unique non-bank financial intermediary, functioning similarly to a shadow bank

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Established during the new village movement in 1963, MGCCC has cultivated a close-knit relationship with grassroots communities across the countryWith total assets reaching approximately 284 trillion won (about 220 billion USD), it boasts over 1,300 branches, serving more than a third of South Korea’s population.

Since last year, the issue of insolvency surrounding project financing loans has persisted unaddressed, with local banks and credit cooperatives becoming the prime casualties of this ongoing financial strain.

MGCCC stands out globally within the finance sector.

The heart of the problem lies within its non-regulated nature – rooted in a government initiative for rural development yet unbound by the oversight of the Financial Supervisory Service (FSS). Even amid tightened mortgage lending policies from 2020 to 2022, applicants found it alarmingly easy to secure loans from MGCCC, making it a last resort for many small and medium-sized enterprises and individuals.

Projects deemed too risky by traditional banks suddenly became viable with MGCCC’s loans, accumulating risk that now presents a clear threat.

In early July, reports surfaced indicating that over 20% of certain MGCCC branches faced default rates, triggering a wave of panic withdrawals.

The igniting fuse had been lit.

Governed by the Ministry of the Interior and Safety, MGCCC was not required to disclose its operational details to financial oversight institutions

It was only after its soaring default rates were exposed that the government confronted an alarmingly precarious situation.

In response to the growing crisis, the ministry swiftly announced a joint investigation into 30 branches with default rates exceeding 10%. As of July 6, MGCCC had a total loan amount of 196.8 trillion won (roughly 151 billion USD), with a 6.18% default rate.

The public was astounded; thirty branches of MGCCC were reporting staggering default rates!

This prompted even more people to withdraw their funds, escalating the run on the shadow bank.

Further investigations revealed that MGCCC’s bankruptcy risks primarily stemmed from its credit division, which had aggressively extended loans to the real estate sector despite the increasing interest rate landscape.

What does this mean for depositors?

The current mood has shifted to one of urgent liquidity preservation in the face of a run on deposits.

As of July 10, reliable sources indicated that South Korea's financial regulators requested the major commercial banks to prepare approximately USD 4 billion in funding to stabilize MGCCC, which was grappling with a wave of customer withdrawals.

A Korean financial services official noted, “Although we cannot confirm specific amounts or details, we have asked the banks to cooperate and extend liquidity through repurchase agreement loans to assist MGCCC.”

Citing the sensitivity of the situation, the unnamed official refrained from providing additional comments.

Sources revealed that South Korea's five largest commercial banks were either signing or had already signed repurchase agreements with MGCCC to exchange collateral for cash

Each institution is expected to prepare 1 trillion won, totaling a potential support package of 5 trillion won (approximately 3.84 billion USD).

Interestingly, combined statements from the Bank of Korea, the Ministry of Finance, and financial service authorities indicated that withdrawals at MGCCC had begun to slow, even as new deposits grew.

Is the crisis over? Not quite, as the situation evolves.

As reports emerged on Tuesday, July 11, Korean state-owned banks, including the Industrial Bank of Korea and Korea Development Bank, prepared to extend at least 2 trillion won (around 1.54 billion USD) in liquidity to MGCCC through repurchase agreements.

With now seven banks involved, including the two state-owned lenders and the five major commercial banks, the situation is undeniably serious.

Such a coordinated effort signifies ramifications that could ripple throughout the financial system.

Coverage has revealed how the influx of “positive” news paradoxically prompted more citizens to join the bank run.

Despite this, the reports claimed that the run on MGCCC did not seem to affect South Korea's major commercial banks, as indicated by stable credit default swap (CDS) prices following a spike at year-end.

For context, a CDS serves as a form of insurance against the risk of credit default, making its price directly related to perceived default risk.

As of July 12, news indicated that the Bank of Korea was scheduled to hold a monetary policy meeting amid growing concerns

Many experts speculated that the Bank would refrain from hiking interest rates, particularly given the implications of the MGCCC situation.

With the uptick in MGCCC’s default rate, anxieties surrounding possible credit tightening have continued to mountAnalysts including Huh from Daol Investment Company cautioned that while the government maintains these risk factors are manageable, public apprehension doesn’t seem to dissipate.

Drawing parallels, Zoltan noted that if a crisis engulfed small banks in the U.S., shadow banks could serve as a prime observation pointToday, the scenario unfolding in South Korea presents a compelling case study of shadow bank crisis dynamics.

How much liquidity can South Korea's banks afford to funnel into MGCCC? Will that liquidity suffice? If not, could MGCCC face a catastrophic collapse?

The fallout from the shadow bank run ultimately injures the everyday citizen, despite the crisis existing outside traditional banking frameworks.

On MGCCC's homepage, the chairman addressed clients in a reassuring message:

“Having weathered five decades of challenges, our community credit cooperatives are presently focusing on preparing for the next century