Are UK businesses facing catastrophe due to vast coronavirus debt burdens?

The coronavirus pandemic has delivered the largest economic shock to the UK economy in three centuries.

And yet, even as their revenues have collapsed, the number of British business insolvencies has, remarkably, fallen, not risen, this year.

This is, in large part, because firms have been able to access special state-backed bank loans.

“Businesses and individuals from Land’s End to John O’Groats have been affected by Covid-19 and the only reason this hasn’t shown up in the insolvency statistics yet is because of the extensive support the government has provided,” says Colin Haig of restructuring trade body R3.

“Without it, we’d be in a very different situation – and a very grave one at that.”

Under various state-backed schemes rolled out by the Treasury since May, 1.5 million firms have tapped some £65bn of credit.

British business has, in short, been forced to borrow on a vast scale this year to survive.

Yet with the future for many sectors of the economy still deeply uncertain – and the new state-backed loan schemes all due to expire in January – has this merely delayed the inevitable crisis?

Has this borrowing created a simply unsustainable burden on many firms? And should the government be exploring radical options to lift it?

First, it’s worth establishing how big the problem is for business.  

In a typical year the Bank of England estimates that the UK corporate sector would have a cash flow deficit – more money going out than coming in – of around £100bn.

This is an estimate of the amount of cash leaving the corporate sector in the form of dividends to shareholders or the cash spent by managers to buy back shares from investors.

But the Bank estimates that in the 2020-21 financial year, this corporate deficit will almost double to £180bn because of the slump in revenue.

In normal times companies meet cash flow deficits by running down their cash buffers or by raising new money from investors or bank loans.

Larger companies have issued a large quantity of new bonds and shares this year, but smaller companies have primarily filled their deficits through those state-backed loans, mainly the Bounce Back loans programme.

Net bank lending to UK small and medium-sized enterprises (SMEs) in the year to October was more than 40 times higher than the average of previous years, according to Bank of England data.

The Bank says smaller firms will need more assistance. And the Treasury has said that it is working on a successor scheme to the loan schemes established this year.

But a great deal will hinge on the terms of the scheme.  

The Treasury’s original Coronavirus Business Interruption Loans Scheme (CBILS) in March was criticised for failing to get money out of the door to firms rapidly enough during the first lockdown, threatening a cascade of business failures and redundancies.

This is because the private banks that were administering the scheme were assessing borrowers’ creditworthiness strictly and sometimes asking business owners to put their homes up as security for the loans.

The Treasury established the Bounce Back loans scheme to be far simpler and easier to access, with much lower access restrictions.

But there was a trade-off. Lower rigour enabled money to be delivered to firms more rapidly, but it meant a heightened risk of fraud and of money going to firms which might, realistically, never be able to repay the loans.

The National Audit Office (NAO) has estimated that £15bn to £26bn could be lost from the scheme due to fraud, organised crime or default.

The Office for Budget Responsibility has pencilled in losses for the taxpayer of between £22bn and £40bn over the coming five years.

Leaving aside whether loosening the loan access terms earlier this year was the right decision or not, another key judgment looms.

If the government decides to make the successor loan scheme considerably more rigorous many firms could find themselves once again facing insolvency.

Research by the Office for National Statistics suggests a third of firms could find themselves in financial distress in the coming three months.

Redundancies, which have already hit a record level in the most recent quarter, could spike still higher.

While ministers might be concerned about throwing good money after bad, and also creating more opportunities for fraud, there is also a danger of doing unnecessary damage to the corporate sector.

While parts of the economy might be recovering, there is also the possibility of a no-deal Brexit hitting certain sectors such as agriculture and manufacturing very hard. 

And the coronavirus vaccines will probably not be fully rolled out for many months. Many firms might well be viable, but if they are given a bridge into the second half of the year. 

But are soft state-backed loans the only option for creating that bridge?

The Institute for Public Policy Research (IPPR) think tank argues in a new report that ministers should be looking at taking equity stakes in firms.

The former Conservative Treasury minister and economist Lord O’Neill has also proposed something similar, through an arm’s-length investment body.

The case for this is not only to help companies survive in the short term, but to prevent excessive debt burdens damaging them in the long term.

There is some evidence that high corporate debt (or leverage) deters firms from investing, which impedes their productivity growth.

Other countries have also shown that governments can use equity stakes in private firms to deliver public policy objectives. 

“The UK is actually an outlier among major economies for not already using public equity injections to support businesses,” points out George Dibb of the IPPR.

Yet whatever their theoretical merits, a practical problem with state equity stakes, as opposed to loans, is that the government would have to create new public institutions for both injecting them (including assessing eligibility) and administering them. It’s far from clear whether civil servants could do this in a hurry.

It’s also unclear how appropriate state equity stakes are for very small firms, which have been the dominant users of Bounce Back loans.

Possibly a more practical alternative, which some have proposed, is to making the loans to firms contingent on how the business performs financially in future – so if the company prospers the debt is fully repayable, but if it does not, it is written off. 

But whichever road the government decides to go down to assist a legion of vulnerable UK firms in 2021, it needs to decide soon.