Corporate Insolvencies, Debt Overhang and Loan Guarantee Schemes During and After the Pandemic

Friday, November 26

Ms. Lilas Demmou, Organisation for Economic Co-operation and Development
Mr. Guido Franco, Organisation for Economic Co-operation and Development 
Mr. Ivan Huljak, Croatian National Bank

Mr. Rilind Kabashi, Economist, Joint Vienna Institute

The COVID-19 pandemic triggered a massive global economic downturn. In response, national and international authorities around the globe launched an unprecedented set of policy measures to cushion the economic impact of the crisis and to support the recovery process. Many of these measures focused on providing support to the corporate sector. The webinar took stock of the support to the corporate sector provided during the pandemic and discussed the challenges ahead.

Lilas Demmou started with an overview of the developments in the corporate sector during the pandemic, including the observed decline in bankruptcy rates and the role of policy support in preventing liquidity shortfalls and insolvency. While this "hibernation" strategy was successful, it does entail risks in terms of future productivity, especially regarding business dynamism (via creative destruction and reallocation among incumbents) and over-indebtedness. The results of recent research of these issues show that various measures undertaken to address liquidity shortfalls in the wake of COVID-19 outbreak (policy measures and loan guarantees) were highly efficient, as the share of companies likely to become illiquid moved close to the one expected in normal times for all productivity profiles. Further investigation shows that policy support was highly effective in shielding highly productive firm from becoming illiquid, while at the same time there is limited evidence of support having been provided to "zombie" firms. Regarding the medium-term impact, particular attention was paid to the role of loan guarantees, and results show that they tend to weaken the link between productivity and employment growth, thus worsening the allocation of resources, with the result being driven by large-scale guarantee schemes.

Guido Franco proceeded with looking into the over-indebtedness channel, with the rise of corporate indebtedness in the wake of the pandemic entailing two important risks that could threaten economic recovery: an enduring risk of an insolvency wave and risk of debt overhang affecting corporate investment. He then presented results of the research on these two risks, building upon the previous discussion by Lilas Demmou. A significant share of firms is predicted to face a deterioration in the solvency profile; there is also some heterogeneity, with firms in communication and professional services, old firms and large firms much less affected. Regarding debt overhang, the higher leverage is expected to affect corporate investment, with the magnitude of this impact differing according to leverage ratios. Turning to policy recommendations, there are three main areas for action for the forthcoming policy support withdrawal. First, it is important to preserve the achievements during the pandemic, while at the same time further fine-tuning and targeting viable firms in order to avoid resource misallocation. Second, dealing with debt overhang will require efforts to strengthen firms’ equity and setting up procedures for early debt restructuring. Finally, complementary structural policies will also be needed, aimed at boosting firms’ entry, ensuring digital diffusion across all firms and preserving competitive markets.

Ivan Huljak delved into the policy response to the COVID-19 pandemic in Croatia. An overview of the economic developments was provided, particularly in the corporate sector, with the less than expected fall in profitability attributed primarily to the effects of policy support. Regarding financial leverage, the moratorium scheme in Croatia was explained, including the heterogeneity in their use by firm’s sector, depending on sales decrease in 2020. Overall, moratoria were an effective tool, but they only have a limited scope because most companies do not have bank loans. Moving to the operating leverage, he emphasized the increasing trend in corporate fixed costs share in recent years, which is making the corporate sector more sensitive to sudden stops in business activity. Implemented fiscal schemes helped companies to maintain their capacities during the recession stage, including employment, which allowed for faster growth during the recovery stage. However, there is some indication that non-viable companies benefited disproportionally from employment support schemes. Finally, while it may be too early to assess effectiveness of support measures, solid corporate revenue confirms the undergoing recovery, while the corporate loan portfolio quality remains stable.

Rilind Kabashi, Economist, JVI


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