BIS has published a brief note or Bulletin on the economic effect of COVID-19 outbreak on corporate sector liquidity. Based on a sample of 40,000 listed and large unlisted non-financial firms across 26 advanced and emerging economies, this Bulletin estimates that if 2020 revenues fall by 25%, then, in the absence of any rollover, debt service and operating expenses will exceed cash buffers and revenues in more than half of the firms sampled. Given this challenge, the Bulletin makes a strong case for policy interventions to avoid the negative consequences for the economy and financial markets.
In the short run, the COVID-19 shock challenges corporate liquidity by impairing corporate cash flows, which will likely go deeply negative for many firms as they are unable to cut their costs in line with plunging revenues. In addition, a number of factors compound this problem. Existing credit lines could provide firms with additional resources to help them meet short-term liquidity needs. However, credit lines often have a short-maturity and under the current stressed conditions banks may be reluctant to renew them. Taken together, these factors are placing enormous strains on corporate cash buffers. Both the ability of firms to roll over debts and the size of their cash buffers will have strong influence on their ability to cover operating losses and debt-service obligations.
Many governments have already taken bold action to avoid negative consequences for the real economy and financial markets. Bridging loans would help ensure that the sudden stop to corporate cash flows does not lead firms to a near term default on operating expenses, wages and salaries, or short-term obligations. However, such credit will increase corporate leverage, potentially creating solvency challenges further down the road. Given the size of existing credit lines, authorities may need to develop policies to monitor draw-downs and availability. One risk is that banks do not roll over expiring facilities. In this regard, governments can ease the rollover of credit lines by providing guarantees or credit enhancements. This would reduce bank capital needs when corporates use them.
The Bulletin emphasizes that mechanisms to prevent the seizing of trade credit would also be important. For example, schemes that help firms sell their receivables or receive credit against them, at least partly, may be needed. One possibility would be for central banks to offer a facility where certain short-term claims collateralized with specific types of assets can be re-discounted. Another would be for governments or a single government-related entity to take advantage of centralization to net out trade credit assets and liabilities. To be sure, such schemes would face limitations, not least in terms of moral hazard (manipulation of trade credit accounts) and adverse selection (assets on most risky borrowers would be submitted first). However, limiting such a facility to firms that did pay taxes over previous years and, hence, have been profitable and to assets and liabilities contracted prior to the virus outbreak could mitigate these limitations.
Keywords: International, Banking, COVID-19, Liquidity Buffer, Liquidity Risk, Credit Risk, Loan Guarantee, Regulatory Capital, BIS
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