Stimulus prevented a global flood of post-COVID insolvencies; bankruptcy reforms remain urgent

Two years of pandemic has dealt extreme disruption to businesses around the world. Yet, the expected flood of corporate bankruptcies hasn't materialized. Recent data suggests that insolvency filings have remained stable, or even declined in some countries. This is due to a combination of factors, including legal and regulatory forbearance and an increased use of out- of-court workouts to resolve business distress, as well as trillions of dollars of financial support from governments.

The danger hasn't passed. Stimulus measures have given troubled firms extra time and may be masking deeper vulnerability of businesses, particularly in emerging markets and developing economies (EMDEs). Studies from the World Bank Group and other sources report that global financial risks have risen since the start of the pandemic, partly because firms have borrowed to tackle liquidity shortfalls while declines in company earnings have worsened the ability of firms to service debt. Meanwhile, the pandemic has contributed to changes in consumer behavior that could make some business models unsustainable once the crisis ends.

It is imperative that regulators and policymakers use this extra time to shore up insolvency systems to ensure business failures are resolved fairly and quickly , so that resources can be restored to productive economic activity as soon as possible.

EMDEs are particularly prone to private sector solvency crises that are more easily avoided in advanced economies, which have higher vaccination rates, extensive fiscal and policy support buffering the private sector from effects of the pandemic, and greater availability of corporate restructuring frameworks.

In many EMDEs, the problem is amplified by the high levels of corporate debt that existed before the crisis. A large number of corporate debtors in these countries are at risk of cash flow or balance sheet insolvency, in the event of a sudden shock to earnings. There is a markedly increased risk that micro-, small-, and medium-sized enterprises, which account for many jobs, could be forced to close, particularly in countries where vaccines aren't widespread, and lockdowns continue.

To preserve value and address debt overhangs in the event of a spike in corporate bankruptcies, EMDEs and advanced economies will need to rely on workouts , which help prevent unnecessary insolvencies and limit the growth of non-performing loans that could affect the health of the financial sector. To help policy makers navigate, the World Bank has released its updated Toolkit for Corporate Workouts which spells out possible ways of facilitating fast, flexible, and cost-effective solutions to address firms' financial problems without overburdening the court systems.

As underlined by the Financial Stability Board (FSB), policy makers should address debt overhangs, including by making it easier for non-viable companies to exit the market and free up resources for viable firms. The FSB emphasized that out-of-court workouts play a useful role in dealing with high numbers of cases of distress, benefit from a proactive approach of the market participants and reduce reliance on court systems.

The current crisis has put a spotlight on workout frameworks, especially out-of-court or hybrid procedures, which can provide flexible and cost-effective solutions to address firms' liquidity and solvency issues while reducing the burden on courts. Some countries implemented reforms to their corporate workout frameworks in the wake of the COVID-19 pandemic, although many EMDEs remain in need of reforms to resolve the challenges for businesses at risk.

Strengthening out-of-court restructuring frameworks can help ease the transition from the temporary fiscal and regulatory support measures implemented by many governments. Reliable information about restructuring activity among small- and medium-sized businesses is difficult to obtain, but there have been widely publicized instances of bigger companies-such as airlines, car rental companies and other companies in the travel and tourism sector, or major retailers-undertaking restructurings.

Effective corporate rescue frameworks are positively associated with increased returns to creditors, better access to credit, job preservation, and the promotion of entrepreneurship and venture capital - fundamentals that are all positive for private sector development and economic growth. Corporate workout frameworks are key to the effective management of non-performing assets, but also play an important role in protecting the health of the financial sector. This is particularly the case in EMDEs where financing of nonfinancial companies is predominantly provided by the banking sector.

After the Asian financial crisis of the late 1990s and the global financial crisis of 2008-2009, policy makers have increasingly understood that there is no single, "silver-bullet" policy response to address high levels of corporate distress and related non-performing loans. Instead, corporate restructuring, or business restructuring, can take many forms, via a range of informal to formal procedures that can be used to address differing levels of financial distress.

The Toolkit for Corporate Workouts provides a road map for policy makers considering the reform of a corporate restructuring framework and others seeking to enhance their understanding of the fundamentals of corporate workouts and learn from the most recent corporate workout models and practices across the globe.