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Follow UsArticle by Federico J. Díez, Romain Duval, Chiara Maggi and Nicola Pierri
The pandemic has hit small and medium enterprises particularly hard, partly because they are predominant in some contact-intensive sectors like hotels, restaurants, and entertainment. As a result, many advanced economies risk experiencing a wave of liquidations that could destroy millions of jobs, damage the financial system, and weaken an already fragile economic recovery. Policymakers should take novel and swift action to alleviate this wave.
Abundant liquidity support through loans, credit guarantees, and moratoria on debt payments have protected many small and medium enterprises from the immediate risk of bankruptcy. But liquidity support cannot address solvency problems. As firms accumulate losses and borrow to keep carrying on, they risk becoming insolvent—saddled with debt well over their ability to repay.
New IMF staff research quantifies this solvency risk, and the findings are concerning. The pandemic is projected to boost the share of insolvent small and medium enterprises from 10 percent to 16 percent in 2021 across 20 mostly advanced economies in Europe and the Asia-Pacific region. The increase would be on a magnitude similar to the rise in liquidations in the 5 years after the 2008 global financial crisis, but it would take place over a much shorter period of time. Projected insolvencies put about 20 million jobs at risk (i.e., over 10 percent of workers employed by small and medium enterprises), roughly the same as the total number of currently unemployed workers, in the countries covered by the analysis.
Further, 18 percent of small and medium enterprises may also become illiquid (they may not have enough cash to meet their immediate financial obligations), underscoring the need for continued liquidity support./smstreet/media/post_attachments/dG99uBgUUfzH2Kqu4lQP.png "publive-image")
The implications for banks are another cause for concern. Rising small and medium enterprise insolvencies could trigger defaults and cause significant write-offs, depleting banks’ capital. In hard-hit countries—mostly from Southern Europe—banks’ capital tier 1 ratios (a key measure of their financial strength) could decline by over 2 percentage points. Smaller banks would be hit even harder, as they often specialize in lending to smaller businesses: a quarter of them could experience a drop of at least 3 percentage points in their capital ratios, while 10 percent could face an even larger fall of at least 7 percentage points.