An Analysis of the Personal Bankruptcy Decisions in Korea

Author: Kyeongwon Yoo(Economist, Institute for Monetary and Economic Research, the Bank of Korea)

Although the soundness of household debt in Korea appears to be inferior
to that in the advanced economies, the number of personal bankruptcy
filings seems to be much less than would otherwise be the case considering
the size of the population and economy. This implies that only limited
recourse is had to personal bankruptcy in Korea and points to the existence
of a number of what are for all intents and purposes individual bankruptcies
in Korea for which no applications are filed. This paper analyses the reason
for this and estimates the size of such informal bankruptcies using data on
debtors who have a history of bad credit and on personal bankruptcy filings.
Analysing household bankruptcy decisions, we try to answer the reason for
the recent dramatic increase in personal bankruptcy filings and offer some
policy implications concerning this situation.
This paper suggests that personal bankruptcy decisions involve three
phases: default, informal bankruptcy, and filing. It has been suggested that
the major factors affecting personal bankruptcy decisions include adverse
events such as illness and unemployment; financial benefits, option value,
and opportunity costs from filing; and the law on the garnishment of
earnings. The empirical results show that the probability of filing for
bankruptcy is likely to increase in line with the financial benefits and after
debtors experience an income shock.
Based on these results, firstly, we argue that the government needs to help
the poor accumulate financial assets as a buffer against income shocks.
Correspondingly, the processing of filings and adjudications of bankruptcy
in the court should be applied less restrictively to debtors who have actually
lost their repayment capacity. Secondly, financial education should be
provided for the poor to prevent debtors from falling into the status of
informal bankruptcy. Lastly, considering the strategic behavior of debtors,
caution should be exercised in changing legislation concerning personal
bankruptcy in the future.