The Bank of Korea stated on Wednesday that while South Korea's financial system remains stable, increasing property and stock prices are fueling a rise in leveraged investments, which could worsen financial imbalances.

The central bank noted in its Financial Stability Report, "Despite domestic and external uncertainties, the Korean financial system is assessed to be stable overall, supported by sustained growth of the real economy, the sound resilience of financial institutions, and the country's external solvency."

"However, given that volatility in domestic financial and foreign exchange markets has increased significantly, latent risks remain potential sources of instability and require close monitoring," the report added.

The Bank of Korea identified potential risks, including a worsening of financial imbalances due to resurgent home price surges in Seoul and other areas, an increase in leveraged investments, and concerns over the spread of non-performing loans in vulnerable sectors.

Household loans in South Korea grew by 3.5% year-on-year in the first quarter to 1,993.1 trillion won (approximately $1.3 trillion), a relatively moderate pace. However, the monthly growth rate of household loans has accelerated in recent months, influenced by rising home prices in the Seoul area.

The central bank stated, "The pace of household credit growth has picked up again, and it is notable that credit risk remains high for vulnerable household borrowers and firms in some sectors."

The report highlighted that South Korea's financial markets experienced significant volatility in the first half of the year due to the depreciation of the won and net foreign capital outflows.

In recent months, the won has weakened against the US dollar, falling from around 1,400 won in the first quarter to around 1,500 won. As of June 9, foreign investors recorded net sales of South Korean assets totaling $83.37 billion.

The Bank of Korea also warned that increased participation in leveraged stock trading during the recent market rally could lead to price corrections, potentially amplifying stock market volatility.

Accelerated growth in non-mortgage household loans in the fourth quarter of last year and the first quarter of this year has led many to believe that a significant portion of this borrowing has flowed into the stock market.

The central bank said, "As market interest rates rise, expectations for asset price increases and risk appetite are projected to decline, which will help mitigate the risk of worsening financial imbalances."

"However, in the short term, volatility in financial markets and the risk of default in vulnerable sectors may increase," it cautioned.

Given rising inflation pressures and robust economic growth, the Bank of Korea has hinted multiple times at a potential near-term interest rate hike, having kept its benchmark rate unchanged for an eighth consecutive meeting in May.

Last week, Bank of Korea Governor Shin Hyun-song pledged to "actively take measures to curb inflation" until confident it is steadily moving toward the target level.