Is a wave of bankruptcies about to hit the global banking system?

Through John manning, international banker

As the pandemic swept the world early last year, many expected an increase in bankruptcies to materialize following prolonged shutdowns, which have severely curtailed economic activity. But with most governments moving quickly to implement emergency measures for businesses, the number of bankruptcies completed during the COVID-19 era has so far been significantly lower than was widely expected. This gap therefore continues to beg the question of whether an impending tidal wave of bankruptcies is about to hit the global banking sector, as these emergency measures are gradually phased out in the face of a steady economic recovery.

The pandemic has seen companies take on significant debt to survive the long and frequent foreclosures that have often resulted in dramatic slowdowns in sales. These decisions were undoubtedly facilitated by the granting of state guarantees and the stimulus measures of the central bank. Earlier this year, for example, the Spanish government approved an 11 billion euro plan to help businesses repay debts accumulated during the pandemic, including 7 billion euros in direct aid to businesses and 4 billion euros. ‘euros for a possible debt restructuring. But now, as authorities attempt to wean them off that support, the very real likelihood of bankruptcies may well strain banking sectors.

While state support has certainly boosted corporate liquidity, it is not yet clear exactly what it did to prevent insolvency. As the International Monetary Fund (IMF) wrote in April, the abundant liquidity aid through loans, credit guarantees, and debt repayment moratoria may have protected many small and medium-sized businesses ( SMEs) from the immediate risk of bankruptcy, but such programs cannot solve solvency problems. “As businesses rack up losses and borrow to keep going, they risk becoming insolvent – struggling with debt far beyond their ability to repay. “

Indeed, the IMF expects the pandemic to increase the share of insolvent SMEs from 10% to 16% this year in 20 mostly advanced economies in Europe and the Asia-Pacific region. “The increase would be of a similar magnitude to the increase in liquidations in the 5 years following the 2008 global financial crisis, but it would take place over a much shorter period,” the IMF wrote in April. “Projected insolvencies endanger around 20 million jobs (i.e. more than 10% of workers employed by small and medium-sized enterprises), roughly the total number of workers currently unemployed, in the countries covered by the analysis. The Fund also predicts that 18% of SMEs could become illiquid in that they may not have enough cash to meet their immediate financial obligations.

Thus, corporate insolvencies and possible defaults could end up resulting in substantial write-offs, which would put a strain on banks’ capital buffers. The IMF sees banks’ Tier 1 capital ratios in the hardest-hit European countries, mainly in the south of the continent, fall by more than two percentage points this year, if not more. “Small banks would be hit even harder, as they often specialize in lending to small businesses: a quarter of them could experience a drop of at least 3 percentage points in their capital ratios, while 10% could face an even larger drop of at least 7 percentage points.

So, is a wave of insolvencies almost guaranteed? Many seem to think so. An EU (European Union) document obtained by Reuters in February, for example, showed that the bloc would face an increase in bankruptcies and bad debts once the post-pandemic economic recovery begins to take hold and governments begin to pull back public programs that keep many companies under respiratory assistance. “Once the unprecedented public support measures expire, a number of companies are likely to default on their debts, leading to an increase in non-performing loans and insolvencies,” the note said. It also included a calculation that national liquidity support measures of nearly 2.3 trillion euros are helping eurozone governments avoid an increase in bankruptcies. Without such assistance and additional bank loans, the note also observed, nearly a quarter of EU businesses would have had liquidity problems by the end of 2020, having depleted their cash reserves to contain cash flows. economic devastation caused by the pandemic.

The European Central Bank (ECB) has also recognized the potential for ‘zombification’ of the region’s economy, with many businesses only existing thanks to state aid implemented during the pandemic. The bank recently admitted that policy measures to support businesses and the economy during the coronavirus pandemic “may have supported not only otherwise viable businesses, but also unprofitable but still operating businesses, often referred to as “Zombies” “. With such pressing concerns on the horizon, EU leaders discussed the issue with ECB President Christine Lagarde; Specifically, what happens when these business support measures are removed, and how will a potential wave of corporate insolvencies affect the banking industry? “This is a very significant risk for us,” said Paschal Donohoe, the Irish minister who heads the meetings of the chief financial officers of the euro zone.

Indeed, given the support measures still in place, the currently low number of bankruptcies seems almost certain to mask a sharp increase in the future. At the end of March, for example, official data from Germany showed that the number of company bankruptcies fell last year to its lowest level since 1999, more a reflection of the government’s decision to allow struggling companies to delay filing for bankruptcy than any fundamental improvement in operating conditions in the country. “It’s a paradox: despite one of the biggest economic crises in Germany last year, bankruptcies fell by 15%,” said Ron van het Hof, managing director of credit insurer Euler Hermes in Germany, Austria and Switzerland, to German international media. Deutsche Welle (DW). “It shows how decoupled the insolvency trend is from the actual overall economic situation and the current state of business.”

Likewise, the United States last year saw a 30% drop in personal and business bankruptcy filings compared to 2019 figures. Official data has shown that corporate bankruptcies in England and the country Wales also fell to their lowest level in over 30 years at the start of 2021, again mainly thanks to government support measures in place. And the number of bankruptcies in the EU fell last year vis à vis 2019 levels, again thanks in large part to the suspension of loan repayments and the relaxation of bankruptcy rules in the region.

But not everyone expects bankruptcies to skyrocket in the near future, including the Bank of England (BoE). According to the outgoing chief economist of the UK central bank, Andy Haldane, much of the accumulated corporate debt is spread over long durations, “which increases the chances that it can be repaid and, by therefore, bankruptcy does not recover much from relatively moderate levels ”. Nonetheless, Haldane acknowledges that risks remain and that the BoE will have to “follow them”.

The Bank for International Settlements (BIS), meanwhile, remains undecided about what the future holds in terms of the coming insolvency wave – or the lack of it. “Extending credit to loss-making companies clearly helped prevent the initial liquidity crisis from quickly turning into widespread solvency problems. However, it remains uncertain whether this transition has been canceled or postponed, ”BIS economists Ryan Banerjee, Joseph Noss and Jose Maria Vidal Pastor wrote in March. “The abundance of credit has led to a sharp increase in corporate debt over the past year. For example, in the airline and hotel, restaurant and leisure sectors, the median leverage of loss-making companies increased by almost 20 and 15 percentage points respectively. Thus, the BIS expects the trajectory of future cash flows to play a key role in determining whether this growing leverage ultimately makes companies vulnerable to insolvency.

On the banks’ side, it seems to be a matter of remaining cautious for the time being, especially since the current problems of companies are not reflected in the levels of non-performing loan ratios. “While it is clear that the private sector’s debt service capacity has been affected by the pandemic, government credit guarantees and loan repayment moratoria have so far prevented an increase in defaults.” , indicates the EU rating. “So the overall NPL ratios – based on a fairly stable NPL stock and the increase in the loan denominator – do not yet reflect the underlying deterioration in borrowers’ credit profile.”

However, it is more difficult to assess at this stage whether the global banking sector can emerge from the crisis unscathed, especially given the current fragility of the global economic recovery and its vulnerability to further restrictive measures. Banks in the region were largely healthy before the crisis, according to the European Commission (EC), but risks to businesses and the economy as a whole may well have increased since then. “According to the ECB’s bank lending survey, banks expect to further tighten credit conditions and increase collateral requirements,” the Commission said.

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