ECB Brief: ECB’s Villeroy Plays Down Corporate Insolvency Threat

5 May 2021

By David Barwick – FRANKFURT (Econostream) – European Central Bank Governing Council member François Villeroy de Galhau’s exhortations on Tuesday and Wednesday not to ‘exaggerate the alarms’ with regard to corporate insolvencies may take some of the wind out of the sails of those for whom this issue might become the newest argument for extending policy support ad infinitum.

With insolvencies in France having been artificially depressed by the pandemic, even the recent climb in the numbers has still not meant a return to the level of 2019, he said.

‘A catch-up effect over the coming period would not mean an economic rupture, but a return to a natural rhythm’, he said. As for the risk that insolvencies would do more than simply catch up to the more normal level that might have been expected absent the pandemic, ‘[n]othing can be ruled out, but there is no reason to anticipate this today’, he said.

Villeroy was speaking of France; at the ECB, there has been no all-clear for the area as a whole, but neither do Executive Board members sound particularly worried. Although the topic was not broached at the last press conference two weeks ago, ECB President Christine Lagarde said earlier last month that there is ‘no question’ that bankruptcy filings will increase in the coming period, she said.

Governments must ‘distinguish between liquidity and solvency problems’ and ensure that liquidity constraints do not turn into a solvency crisis, she said, putting the ball in the court of fiscal policy.

In an interview published only Monday, her second-in-command, Luis de Guindos, when asked very directly if he feared ‘an avalanche of bankruptcies’, was circumspect, first framing his answer in terms of what was ‘true … at the beginning of the crisis’, when such a possibility was – not is – ‘one of the biggest concerns’.

Pressed to comment on the current outlook, de Guindos said, ‘There will most likely be an increase in non-performing loans in the second half of the year, but we don’t expect it to be as acute as we feared at the start of the pandemic’, and urged banks ‘to take timely action to minimise any cliff effects’.

In de Guindos’ own country, Pablo Hernández de Cos, who heads Banco de España, is less sanguine, and has hammered home the message of a need ‘to measure this risk carefully and be prepared to adapt our policies to mitigate it as far as possible.’

‘[W]ithstanding the negative consequences of the COVID-19 crisis on the solvency of viable firms is currently a major challenge for policy makers’ he said last week. ‘[W]e now need to be prepared to react to these solvency risks in order to prevent the current crisis from developing a financial component’.

But it is not clear who would have de Cos’ back if he were to pin to this issue a plea for more or longer policy support. Bank of Greece Governor Yannis Stournaras has predicted ‘a new wave of NPLs, as well as an anticipated worsening of the Deferred Tax Credits (DTCs)’, but has also been vocal about the enhanced resilience of Greek banks.

Neither has Banca d’Italia’s Ignazio Visco been too dramatic on the subject. Authorities are called on to help ‘viable firms to pass this transition and re-enter operation in good health’, he said recently. ‘We are monitoring this and this monitoring will certainly lead to a more targeted’ approach, he said, ‘but there will be an increase in NPLs and insolvencies.’

However, pointing to the fortification of the banking sector since the last crisis, Visco affirmed that banks now had ‘certainly more ability to absorb these NPLs. So overall, we are cautiously confident that we will overcome this period in a much better way than we have in the past.’

Cautious optimism has also been the watchword in this respect of Dutch National Bank head Klaas Knot, who not long ago noted that insolvencies had so far been ‘relatively subdued’ and that the economy had ‘done consistently better than we anticipated about a year ago.’ Still, companies, especially in some sectors, had not emerged unscathed, he said.

While the sovereign-corporate-bank nexus entails risk that could materialize in the event of mass insolvencies, he said, ‘Luckily, the risk of such a doom loop has diminished with the vaccines and the prospect of economic recovery. But at the same time, it is clear that the virus will continue to linger for quite some time to come.’

Similarly, Bundesbank President Jens Weidmann has said that the withdrawal of government support measures will eventually lead to higher insolvencies and thus higher loan defaults, he said, ‘but from today's perspective to an extent that the banking sector in Germany can cope with.’

Ultimately, time will reveal the seriousness of the corporate solvency problem. As the economic situation improves with the widening reach of vaccination campaigns, the doves on the Governing Council may be hard-pressed to come up with a reason not to start the exit from extraordinary policy measures. In damping fears of a wave of insolvencies, the normally dovish Villeroy has contributed to the narrowing of their options.