24.11.2020
The impact of the pandemic on the Spanish business sector's
financial situation
1st International Management Congress. APD. Purposeful Business
Pablo Hernández de Cos
Governor
*English translation of the original speech in Spanish
Good afternoon, ladies and gentlemen. First, let me begin by thanking the organisers for
kindly inviting me to take part in this Congress.
My presentation today will focus on the impact of the COVID-19 crisis on the Spanish
business sector's financial situation and on the role that economic policy is currently playing
and should continue to play to mitigate that impact.
Business activity has been particularly affected by the crisis. Many of the economic policy
measures adopted have been designed precisely to minimise that effect. These measures
are and will continue to be crucial, to prevent the temporary shock caused by the pandemic
from resulting in the closure of many businesses and, ultimately, in persistent damage to
our productive capacity.
However, despite the policy measures taken, many businesses have seen their financial
situation deteriorate since the start of the crisis, and how we address this deterioration will
have important repercussions for the macroeconomic outlook in the short and medium term.
Firms that are most financially vulnerable generally invest less and hire fewer employees
than those that are financially sound.1
At the same time, there are now signs that the pandemic may give rise to some structural
changes in consumer demand. And although at this stage it is difficult to define the
magnitude and scope of these changes, it is essential they be identified promptly, since
economic policy cannot provide indefinite support for firms that are headed for a structural
reduction in their activity. Rather, it should aim to encourage and support the adaptation of
the productive system to the new reality and the efficient cross-sectoral and cross-firm
reallocation of resources.
Moreover, the outlook for the Spanish economy and, therefore, for the business sector
remains very dependent on the still highly uncertain course of the pandemic.
Since the beginning of July, the strength of the recovery has been adversely affected by the
fresh outbreaks of the virus in our country and, more recently, by the worsening of the
epidemiological situation both in Spain and in most of Europe. This has prompted the
relatively widespread introduction of new restrictions on mobility and activity in certain
sectors. Accordingly, economic activity in this final stretch of the year and in early 2021 will
foreseeably be less dynamic than was anticipated in the baseline scenarios published a few
months ago by the Banco de España and the ECB for Spain and the euro area, respectively.2
By contrast, the latest news on the availability of a vaccine for early 2021 is clearly positive
and, if confirmed, should help raise confidence and rule out the most adverse economic
scenarios, even though the effects on activity will not be immediate.
In this setting, and considering the potential news flow on a possible vaccine, economic
policy should focus on continuing to provide support for households and firms affected by
the crisis.
The liquidity risks facing firms and the economic policies applied to address them
Let me now analyse the main financial risks that firms face in such a challenging
environment. The two key risks are liquidity and solvency.
The shock has given rise to a sharp fall in firms' revenues, as a result not only of the
pandemic itself but also of the mobility-restricting measures introduced by the authorities
to stop the spread of the virus. This contraction in firms' turnover, together with their fixed
costs, has driven up firms' liquidity needs.
Firms were able to use their liquid assets or undrawn credit lines to meet part of these needs.
But given the scale of the shock, in many cases these buffers proved insufficient. In
consequence, to meet their remaining liquidity needs, firms sought new funding. The result
has been an increase in the demand for credit, in a setting in which lenders' risk perception
has increased.
According to the results of microsimulations made by the Banco de España, 68% of Spanish
firms will record liquidity shortfalls3 in 2020, almost 10 pp more than under a counterfactual
non-pandemic scenario.4
It is estimated that between 2020 Q2 and Q4, the total liquidity shortfall of the business
sector will amount to some €230 billion, €25 billion more than under the counterfactual
nonpandemic scenario if no account is taken of the liquidity needs associated with investment
in fixed assets. Firms' liquid assets and undrawn credit lines would be insufficient to cover
more than half these liquidity needs.
These simulations also show that a large part of firms' total liquidity needs would arise at
low-credit-quality firms. These firms tend to find it more difficult to access credit, especially
in periods of high uncertainty and growing credit risk concerns.
Overall, these results suggest that the pandemic is generating substantial liquidity risk for
Spanish firms.
In this setting, national and supranational economic policies in the different (fiscal, monetary
and financial) areas responded rapidly and robustly to address these risks. After the initial
stress, this resulted in an improvement in financing conditions recorded in both bank lending
and debt securities markets.
In the fiscal policy area, two public guarantee programmes managed through the Official
Credit Institute (ICO) are noteworthy. The first, with a total of €100 billion, was designed to
finance firms' liquidity needs, while the second, with up to €40 billion, was mainly focused
on investment in fixed assets. The aim of both these programmes was to encourage financial
institutions to grant funding to firms and the self-employed, in a setting in which these
agents were facing high liquidity needs, against a backdrop of rising uncertainty and
growing credit risk concerns among lenders.
Since the Royal Decree approved on 17 November came into effect, the maximum term of
loans granted under these programmes has been extended to eight years and the maximum
grace period, which was initially 12 months, has been extended to 24 months. Similarly, the
deadline for granting of guarantees, which was originally 31 December 2020, has been
extended to 30 June 2021. In addition, financial institutions should maintain the limits on
working capital facilities up to that same date for all customers that have a guaranteed loan
and comply with the eligibility requirements.
This Royal Decree has also extended the insolvency moratorium, which was set to expire
on 31 December this year, to 14 March 2021, with the aim of preventing firms that continue
to experience temporary, pandemic-related financial difficulties from having to file for
insolvency. This measure aims to reduce the risk of viable firms being eventually wound up,
with the impact this would have both on the productive system and in terms of job losses.
The available evidence suggests that the economic policy measures taken have helped to
ease firms' financing conditions, which contrasts with what was seen in the international
financial crisis that began in 2008. It is a consequence not only of the swift and forceful
economic policy response, but also of the better financial situation of the banking system
and, in particular, of the larger capital buffers built up by the banks in recent years that have
enabled them to absorb losses in their credit portfolios. The different nature of the current
crisis has probably also been a determinant in this respect.
In any event, since 2020 Q2 firms have resorted to debt on highly favourable terms to cover
part of the increase in their liquidity needs. Specifically, between February and September,
the outstanding amount of corporate sector debt rose by almost 5%. The increase was
concentrated in particular in the months of March, April and May.
The ICO guarantee programme has played an important part in adding momentum to bank
lending. As at 15 November, total funding granted under this programme amounted to
€108,032 million (including the portion intended for the self-employed). Essentially, these
funds have been provided to firms that faced greater funding difficulties, such as smaller
firms and those most affected by the pandemic. In addition, the loans have been granted
on highly favourable conditions, in terms of interest rates and maturities, thus improving the
existing corporate debt maturity structure.
Firms' solvency risks
I will now move on to firms' solvency risks. Lower turnover has a negative impact on firms'
revenues and reduces their ability to repay their debts. In addition, firms that record losses
will see their capital decrease, while if they take on new debt to cover their liquidity needs
their debt ratio will increase. In consequence, the composition of firms' liabilities will
ultimately weaken.
The data available for 2020 already show a deterioration in the financial position of the
business sector. The Central Balance Sheet Data Office Quarterly Survey (CBQ), which has
data on some 900 - mainly large - companies, shows that during the first half of the year,
the average return on assets of the sample of respondent companies fell to 2%, 2 pp below
the figure recorded in the first half of 2019. In addition, the percentage of firms that recorded
losses rose by more than 11 pp, to 37%.5 The survey also shows that, on average, the debt-
to-assets ratio rose by 1.5 pp, while the debt-to-earnings ratio rose more substantially,
owing to the sharp decrease in revenues.
The microsimulation exercises conducted by the Banco de España confirm these trends for
the business sector as a whole in 2020. It is thus estimated that around half of all firms will
post losses this year. However, we see considerable heterogeneity across these firms.
SMEs and, above all, those belonging to the sectors most exposed to the shock, such as
hospitality, leisure and motor vehicles, will be significantly more affected.
The percentage of firms with a high debt-to-assets ratio6 is expected to rise by around 7 pp
for the business sector as a whole, with this increase much sharper in the group of firms
pursuing their activity in the sectors most impacted by the pandemic. In terms of the
debtto-earnings ratio, it is estimated that the proportion of firms in a situation of greater
vulnerability will see the highest increase, owing to the strong decline in revenues. That said,
this indicator tends to overestimate the deterioration in firms' solvency in the current
situation because, in many cases, the level of profits in 2020 is not representative of
expected future profits.
The increase in debt and the decline in revenues affect some firms' debt repayment
capacity. But the extension of maturities and the lower interest rates on new loans granted
during the crisis compared with pre-existing loans are substantial mitigating factors,
contributing to lessening the financial burden on firms. Looking ahead, debt repayment
capacity will depend mainly on the scale of the economic recovery.
Economic policies to address future challenges
Currently, the economy is experiencing a recovery that is incomplete, uneven and subject
to a high degree of uncertainty, caused mainly by pandemic-related developments. This
means that the risks to the business sector will continue to be significant until the pandemic
is under control, especially for the firms most affected by the shock. Allow me now to
summarise the courses of action which, in my view, should be followed in the current
macroeconomic environment.
First, economic policies should continue providing support to the economy. In particular,
we should avoid a premature withdrawal of the support measures and economic
policymakers should monitor risks and stand ready to introduce further stimuli if the
macroeconomic outlook continues to worsen.
In the specific case of micro- and macroprudential policies, and as the Basel Committee on
Banking Supervision has reiterated, banks should use during this crisis the capital and
liquidity buffers introduced by Basel III. That will allow them to absorb financial shocks and
support the real economy by granting financing to solvent households and firms. In this
connection, supervisors will give banks sufficient time to replenish their buffers, taking into
consideration economic and market conditions, along with the circumstances of each bank.
Also, banks' dividend payout and remuneration policies should remain very prudent until
the current uncertainty abates and a sound economic recovery takes root, irrespective of
the decisions adopted on whether to prolong the recommendations currently in force at the
European level. In parallel, we should ensure that the various flexibility measures applied do
not give rise to delays in recognising the effective impairment of the quality of credit
exposures, and provide banks with the necessary incentives to maintain appropriate credit
standards.
In the monetary policy realm, the fragility and heterogeneity of the euro area recovery and a
medium-term inflation forecast far below our target lead us to conclude that there is no
room for complacency. It will thus be necessary to reset our instruments to respond to the
current situation and to ensure that financing conditions remain favourable so as to support
the economic recovery and counter the adverse impact of the pandemic on the projected
inflation path. It will thereby be possible to provide leeway for the fiscal authorities to
continue deploying the measures needed to support households and firms. And it will head
off potential bouts of financial fragmentation and promote inflation convergence towards
our medium-term objective in a sustained fashion, in line with our commitment to symmetry.
Second, in the current phase of the crisis in which problems are more concentrated in
specific sectors, the policies aimed at supporting firms should be adjusted so as to focus
on those most affected by the shock. Further, we should consider a more selective focus
that prioritises support to viable business projects. In the specific case of the public loan
guarantee programmes, some of their parameters may need to be adjusted to encourage
the granting of bank financing to viable firms. Striking the right balance between continuing
to provide the necessary protection and maintaining a sufficient degree of selectiveness will
require practically continuous evaluation and adaptation of these instruments in the coming
quarters.
Third, fiscal support to date has focused on avoiding the materialisation of liquidity risks.
This strategy has been successful but, as a result, firms have amassed more debt. A greater
accumulation of debt might prove unsustainable for firms that already have a high level of
debt. Admittedly, the extension of the grace period and maturity of loans under the ICO
guarantee facilities, approved by the Government this month, will help to alleviate the
financial pressure borne by many companies. But in some cases it would also be advisable
for them to strengthen their solvency position by means of capital instruments. The
€10 billion fund managed by SEPI (the State Industrial Holdings Corporation) enables large
strategic corporations to be recapitalised, but it would be advisable to complement this with
new tools aimed at strengthening the solvency position of smaller companies.
For those firms that are highly indebted but with a viable business, debt restructuring could
be an advantageous option for lenders and borrowers alike. To enable this process,
insolvency arrangements should be improved so as to increase their efficiency. In Spain,
these proceedings are usually dragged out over time (lasting three and a half years on
average7), destroying business value in the process and, on most occasions, ultimately
leading to a winding-up of the company. To prevent congestion in the courts, out-of-court
payment settlements could be promoted. In this connection, we should consider the
advisability of including, under certain conditions, certain public-law claims in these
agreements, and that the public sector's position in these processes should favour a debt
restructuring agreement being swiftly reached. That could be achieved, for example, by
granting incentives to other creditors so that they support the agreements. This would affect
not only public-law claims but also the exposures resulting from the potential enforcement
of some of the guarantees granted to firms and the self-employed under the ICO facilities.
Likewise, in the medium and long term, additional resources could be given to specialist
courts to expedite the resolution of these processes.
As regards firms with inviable business models, the path should be smoothed for their
orderly exit from the market. The swift resolution of these processes will prove conducive
to the structural adjustment of the economy and the reallocation of resources to more
productive firms.
Fourth, our aim should be to prevent the current crisis from causing severe damage to our
financial system. In the context of the uneven and uncertain recovery I have described, we
cannot rule out the possibility that the risks identified may materialise or that their impact
and persistence may be greater than expected.
In this respect, the response by banks to the possible materialisation of these risks must be
pan-European, given the commitment to the banking union. In this response, the completion
of the banking union and the launch of a fully pooled European deposit guarantee scheme
would contribute decisively to ensuring euro area financial stability. Moreover, it is essential
to analyse to what extent European bank resolution and liquidation regulations are
appropriate for a hypothetical systemic crisis, or the possible role of asset management
companies in the event of serious impairment of European financial institutions' balance
sheets.
Lastly, from a more medium-term perspective, other structural policies may smooth change
in the composition of firms' debt so as to give greater preponderance to capital. These
would include reforming the treatment of debt under corporate income tax, and advances
in the capital markets union project that would help provide for the integration and
development of capital markets in the EU.
The growth of equity markets can afford various benefits to the business sector and the
economy in general. The resort to equity funding strengthens the soundness of firms'
balance sheets, given that a greater proportion of these capital instruments reduces firms'
vulnerability to adverse shocks such as an increase in interest rates or a decline in
revenues.8
Conclusions
I should like to conclude by pointing out that the COVID-19 pandemic has prompted an
unprecedented economic contraction in Spain and in other economies. Non-financial
corporations have been seriously affected, although the forceful measures adopted by the
national and supranational economic authorities have prevented the materialisation of a
wave of defaults stemming from short-term liquidity problems. However, some firms have
seen their solvency impaired as a result of a decline in their revenues and an increase in
their debt.
The current phase of the crisis, marked by an incomplete and uneven economic recovery,
warrants continuing public support to firms. Nonetheless, these policies should be adjusted
so as to focus more on firms in sectors that continue to be severely affected by the crisis,
and through means other than the accumulation of greater debt. Debt restructuring
mechanisms need to be more efficient, so as to promptly resolve the insolvency problems
some firms are experiencing. Other structural policies could also contribute to shoring up
the composition of firms' debt in order to assign a greater weight to capital. These policies
might include the elimination of the preferential tax treatment of debt as opposed to equity
and headway in developing equity markets in Europe.
Finally, as mentioned on various occasions, all these measures must form part of an
ambitious reform agenda aimed at tackling our economy's structural problems. These
include most notably high unemployment, labour market duality and the low productivity of
our firms. And, in parallel, we must design a credible strategy for reducing, in a gradual but
sustained fashion, our fiscal imbalances. Such a strategy may be implemented once the
pandemic is behind us and the economic recovery is firmly entrenched. It would entail
significant benefits, by increasing the economy's reform-led potential growth and by
enhancing the credibility surrounding the sustainability of public finances in the medium
term. That, in turn, would increase the existing fiscal space available and would boost the
expansionary effects of the current fiscal measures.
In short, so we may have the fiscal leeway needed to be able to increase support measures
to the economy should pandemic-related developments so require, we must resolutely
implement the reform agenda, plan the fiscal consolidation process and reform support
instruments to make them more flexible and targeted.
Thank you very much.