IMF financial stability report hints at increasing corporate defaults, insolvencies

The latest Global Financial Stability Report of the International Monetary Fund (IMF) has hinted at higher default and insolvency risks in post-pandemic world where governments start withdrawing the policy support.

The report says that due to unprecedented policy support, default rates at large firms have remained well below previous peaks, and bankruptcies among smaller firms have stayed low or even declined in some cases. However, it warns that challenges remain.

IMF cites the number of potential “fallen angels” (firms with a BBB minus rating and negative outlook) has tripled globally since the beginning of the pandemic, and in some jurisdictions (for example, the European Union and the United States) the potential for further downgrades is elevated. In China, defaults by state-owned enterprises in the last quarter of 2020 suggest that addressing financial vulnerabilities continues to be a priority.

“Ultimately, the health of the global corporate sector will depend critically on the evolution of the pandemic and on the extent and duration of policy support. Should investors reassess the prospects for economic growth and the outlook for monetary and fiscal policy, liquidity pressures, and the risk of such pressures morphing into insolvencies, may resurface,” says the report.

The IMF report also predicts that household debt may rise, on the back of accommodative financial conditions. “So far, strains in the household sectors have been mitigated by significant government support and relief programs as well as by declines in interest rates, which have reduced the debt service load. But poorer and marginalized households have been substantially more affected than others,” says the report.

It further adds that vulnerabilities are unevenly distributed among some households, and financial stress may rise if policy support is withdrawn too early or there is an incomplete economic recovery.

However, one positive coming from the report is that banks have not been part of the problem so far. According to it the banks have entered the pandemic with a large amount of capital and high liquidity buffers and have shown resilience so far, and unprecedented policy support has helped maintain the flow of credit to households and firms.

Also Read: Unwinding government support may increase default risks among weaker companies in 2021, says Moody’s

“However, profitability challenges in the low-interest rate environment call into question banks’ ability or willingness to continue to lend in coming quarters. Banks may be concerned about rising credit exposures and increasing non-performing loans once policy support measures end, especially where the recovery may be delayed or incomplete. Banks may also face challenges in generating returns above the cost of equity amid continued compression of net interest margins, a development long evident in Japan and Europe,” says the report by IMF.

Underwriting standards for nonfinancial firms have tightened in some instances and bank loan growth in many countries has remained low or slowed in recent months.