Low global bankruptcies mask underlying malaise

Global bankruptcies declined in 2020 despite a sharp fall in world GDP. This unusual development largely reflects successful government interventions, but disguises underlying financial stress among businesses. Insolvencies could still rise significantly in 2021-2022 and there are longer-term risks of increased ‘zombification’ and rising bad loans at banks.

In a normal year, the decline in world GDP seen in 2020 would have prompted a surge in bankruptcies of 20% or more, with business failures peaking for two to three years after. But this has been avoided due to government support for businesses, moratoria on bankruptcy proceedings, and legal shutdowns.

Still, many firms face financial distress, especially in consumer-facing service sectors. UK survey data suggests that up to 5% of firms are at severe risk of insolvency, and there is a danger that 2021-2022 will see a steep, if delayed, rise in business failures across economies.

It’s good news that in the early months of the pandemic bankruptcies weren’t prevalent among efficient firms – a vindication of government action. However, evidence from Sweden suggests that might have changed as the crisis wore on.

If bankruptcies are staved off with loan forbearance and government loan schemes, this risks displacing the problem to banks – especially those with high exposure to small firms – or to the public sector balance sheet. This could damage productivity growth.

Topics: Coronavirus