Does corporate leverage amplify economic downturns? A dive into the literature

Sudipto Karmakar, Alexandra Varadi and Sarah Venables

This post reviews the literature on the consequences of debt for corporate and macroeconomic outcomes, drawing both on the pandemic period and on previous financial crises. Lessons from previous crises show that high leverage can amplify corporate risks and economic downturns by: increasing reliance on external financing that may dry up in stress; through debt overhang problems; or by increasing linkages between corporates and other sectors of the economy. Corporate debt may also be correlated with negative outcomes in the pandemic as well, but it is still early to draw direct conclusions.

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What do two million accounts tell us about the impact of Covid-19 on small businesses?

James Hurley, Sudipto Karmakar, Elena Markoska, Eryk Walczak and Danny Walker

Compass on old map

This post is the second of a series of posts about the Covid-19 pandemic and its impact on business activity.

Covid-19 led to a sharp reduction in economic activity in the UK. As the shock was playing out, small and medium-sized businesses (SMEs) were expected to be more exposed than larger businesses. But until now, we have not had the data to analyse the impact on SMEs. In a recent Staff Working Paper we use a new data set containing monthly information on the current accounts of two million UK SMEs. We show that the average SME saw a very large drop in turnover growth and that the crisis played out very differently for different types of SMEs. The youngest SMEs in consumer-facing sectors in Scotland and London were hit hardest.

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On the origin of systemic risk

Giovanni Covi, Mattia Montagna and Gabriele Torri

Systemic risk in the bank sector is often associated with long periods of economic downturn and large social costs. In a new paper, we develop a microstructural contagion model to disentangle and quantify the different sources of systemic risk for the euro-area banking system. Calibrated to granular euro-area data, we estimate that the probability of a systemic banking crisis was around 3.6% in 2018. Seventy per cent of the risk stems from economic risks, with fire sales and contagion risk accounting for most of the remainder and only a small role for interbank exposures. Our findings suggest that correlations among banks’ losses play a crucial role in the origins of systemic risk.

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Unemployment risk, liquidity traps and monetary policy

Dario Bonciani and Joonseok Oh

The Global Financial Crisis in 2008 caused a significant and persistent increase in unemployment rates across major advanced economies. The worsening in labour market conditions increased uncertainty about job prospects, which potentially gave rise to precautionary savings, putting further downward pressure on real economic activity and prices. Moreover, in response to the severe drop in demand, central banks worldwide cut short-term nominal interest rates, which rapidly approached the zero lower bound (ZLB), where they remained for a prolonged time. In a recent paper, we show that committing to keep the interest rate at zero longer than implied by current macroeconomic conditions is particularly effective at easing contractions in demand in the presence of countercyclical unemployment risk and low interest rates.

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What types of businesses have used government support during the Covid-19 pandemic?

Will Banks, Sudipto Karmakar and Danny Walker

This post is the first of a series of posts about the Covid-19 pandemic and its impact on business activity.

During the pandemic, UK businesses have received unprecedented levels of government support, set to total 9% of GDP. This has mainly been through the Coronavirus Job Retention Scheme (CJRS), under which 1 in 3 employees have been furloughed, and the government-guaranteed loan schemes that were used by 1 in 4 businesses. Despite the scale of this support, little has been said about which businesses received it. In this post we combine data on loan scheme and CJRS usage with a data set on the characteristics of businesses. We find that small, relatively old and sophisticated, labour-intensive businesses in the sectors most vulnerable to the impacts of the pandemic are most likely to have received both types of support.

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Covid-19 briefing: working from home and worker productivity

John Lewis, Andrea Šiško and Misa Tanaka

The Covid pandemic has led to a large enforced shift towards working from home (WFH) as a result of ‘stay-at-home’ policies in many countries. This led to a resurgence in interest in, and new reignited discussion about, the consequences of greater WFH. In this briefing we review the literature on the impact of WFH on productivity. Across a very diverse literature the key lessons are: impacts depend on the nature of tasks, the share of WFH matters, and there is big difference between enforced versus voluntary WFH. And the caveats are important too: cost savings at the firm level don’t automatically translate into economy-wide productivity gains and evidence on long-run effects remains very scarce.

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Procyclicality mechanisms in the financial system: what we know and some open questions

Robert Czech, Simon Jurkatis, Arjun Mahalingam, Laura Silvestri and Nick Vause

Financial markets reflect changes in the economy. But sometimes they amplify them too. Both of these roles were evident as the Covid-19 (Covid) pandemic materialised. As the economic outlook deteriorated, risky asset prices fell in reflection of that. And those falls were amplified as some investors reacted by liquidating assets. That also amplified increases in financing costs for companies issuing new debt or equity, which could have further damaged economic prospects. Various ‘procyclical’ mechanisms contributed to this macrofinancial feedback loop, as shown in Figure 1. This post reviews findings from research about these particular mechanisms, covering (i) how they work, (ii) how strong they are and (iii) how they might be mitigated. And, where there are gaps, it suggests new research.

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When should policymakers reach for the history books? Some examples from the 20th century

Catherine R. Schenk

The Bank of England co-organised a ‘History and Policy Making Conference‘ in late 2020. This guest post by Catherine Schenk, Professor of Economic and Social History at the University of Oxford, is based on material included in her conference presentation.

Since the Great Financial Crisis started in 2007 there has been renewed interest in using the past as a basis for policy responses in the present, but how useful is history and how is it best used? Certainly, the old chestnut that ‘those who neglect the past are sure to repeat it’ is a valid warning, but how to select the appropriate historical examples and draw the right lessons is a more nuanced exercise that is explored in this post.

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Where is IFRS 9 taking the cost of funding of banks?

Mahmoud Fatouh

IFRS 9 versus IAS 39

In 2018, IFRS 9 came into effect, replacing IAS 39. IFRS 9 has important implications especially for banks, as they mostly hold financial assets. IAS 39 is based on the incurred-loss model, which allows recognition of credit losses (in the form of provisions) only when there is objective evidence of impairment, dividing loans into performing and impaired loans (Figure 1). IFRS 9 introduces the more forward-looking expected loss model, under which provisions are equal to the expected credit losses. As illustrated in Figure 1, IFRS 9 classifies loans into three stages: Stage 1 loans (performing loans), Stage 2 loans (underperforming loans) and Stage 3 loans (nonperforming loans).

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The Real Effects of Zombie Lending in Europe

Belinda Tracey

‘Zombie lending’ occurs when a lender supports an otherwise insolvent borrower through forbearance measures such as repayment holidays and temporary interest-only loans. The phrase was first coined for Japan in the late 1990s, but more recently several authors have documented that zombie lending to European firms has been widespread following the sovereign debt crisis (see Acharya et al (2019), Adalet McGowan et al (2018), Banerjee and Hofmann (2020), Blattner et al (2018) and Schivardi et al (2017)). In a recent paper, I examine whether these lending practices contributed to the subsequent low output experienced by the euro area. My findings suggest that zombie lending had negative consequences for output, investment and productivity in the euro area over the period 2011 to 2014.

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