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Insolvency: the risks of overexposure

Author: ICAEW Insights

Published: 06 Jul 2022

In the UK, insolvencies are already at a 60-year high. But how widespread is the problem and will it increase? Could trigger a wave of insolvencies present a systemic risk?

A perfect storm of causes is taking its toll on the number of insolvencies: COVID-19, global supply chain disruption and now pressures from the war in Ukraine. 

While widespread insolvencies were predicted at the outset of the pandemic, this did not materialise because of unprecedented business support from the government. “Businesses have had a lot of help in relation to furloughs and all of the different fundings which has kept them afloat, and therefore they’re cash positive,” says Charles McManus, Group CEO, ClearBank Ltd UK.

“The problem now,” he continues, “is that, because of rising interest rates, inflation, less retail spending, economic recession, rising energy prices and so on, without more help, insolvencies are going to become a lot more widespread.”

McManus believes that insolvencies becoming a systemic risk is some way off, but no one should feel complacent. “Systemic risk means 30-40%,” he says, “and in terms of the market, we’re nowhere near that. But all the warning signs are that, over the next few years, if there’s not more help then more businesses definitely will go bust.”

How exposed are banks?

The link between the quality of a country’s insolvency systems and the availability and cost of credit means that a rise in insolvencies and a rise in the cost of credit tend to go hand in hand.

Some banks, says McManus, are massively exposed. “In order to get through the crisis, small businesses borrowed at cheap rates from several banks. The problem now is as their margins and cash flow become squeezed, they can’t pay those debts back. And that means the banks that lent the money are going to get defaults and the government is ultimately going to have to pay the bill for all this default.”

Banking is not the only industry to be affected by the insolvency powder keg. Insurers and investors will also have to try to limit their exposure, although Andrew Hodson, Risk, Information, Claims and Collections Director at Allianz Trade in UK and Ireland, part of the world’s leading trade credit insurer, says: “We’re acutely aware of the challenging credit conditions that lie ahead for business.”

Private capital watches and waits

If public companies are running large debts, how exposed are privately owned or private equity-owned companies?

“Public companies through sheer scale can weather the storm, but the whole private equity market has changed fundamentally in the last few weeks and months,” says McManus. “The valuations of a lot of those private equity companies are coming down and that means the private equity firms are not putting up new capital.”

There may be trouble ahead

Consumer credit is a particular area of concern. The role of central banks is to keep raising interest rates to control inflation, but that tips more people into financial hardship – and the last thing they will be thinking of is paying for the ‘buy now pay later’ sofa. “As far as lending covenants are concerned, you sign those agreements, thinking those events will never happen,” says McManus. “In a credit crisis, they will start to bite.”

The UK Government, along with others, has a lot of work to do.

You can read a longer, more detailed article about this from the Financial Services Faculty here: Indecent exposure?

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