Banking credit quality outlook in Europe

The European Commission elaborated a note to the Eurogroup describing the state of the play of the corporate solvency of European enterprises, through an overview of  the corporate debt dynamics, the liquidity position, the financial conditions expected going forward and the Covid-19 support schemes provided by the governments of the European union.

The note includes the following conclusions:

• The Covid-19 public support schemes have been vital to keep many businesses afloat during lockdowns: The Covid-19 crisis has had a significant impact across the corporate sector “without accounting for government support measures or new borrowing, 23% of EU companies would have experienced liquidity distress by the end of 2020 after exhausting their working capital buffers”.
• The impact of the pandemic on the financial position of companies differs among countries due to a combination of factors such as, for example, the countries’ output structure, the initial indebtedness levels, the impact of the crisis and the strength of containment measures: “firms that are in liquidity distress after exhaustion of working capital buffers ranges from 8% of all firms in the manufacturing of computers and electronics to 75% in the accommodation and food services sector”.
• According to the note, the end of the government support measures (Government loan guarantees and moratoria schemes) together with the uncertainty about future revenue prospects and higher corporate levels of debt will likely increase the volume of NPLS across Europe, however “the timing and magnitude remains uncertain”.
• To deal with this situation of greater delinquencies and business insolvencies, some factors will continue to be relevant:
  - Government support measures, which is expected to evolve from a blanket approach to more targeted actions “to firms that both need it and are viable”
  - Sound insolvency and pre-insolvency procedures will be key for dealing with a potential surge in corporate insolvencies. Efficient insolvency frameworks are needed to make sure that viable debt is repaid, while unviable debt is quickly resolved.
  - The provision of credit will remain essential:  As firms exhaust own funds and support schemes taper off, it will be essential to preserve an effective credit channel. In this regard the note alerts that “in the third and particularly in the fourth quarter of 2020, euro area banks had, on aggregate, started to tighten credit standards to companies, particularly SMEs, as perceptions of company level and economy wide risks increased”.