FSB highlights debt-bias in corporate funding

The Financial Stability Board says cutting tax biases in favour of debt would reduce corporate demand for credit.

The Financial Stability Board is assessing what factors could be incentivising firms to choose to issue debt rather than raise equity.

The FSB published a paper called ‘Corporate Funding Structures and Incentives’ today (22 September), after it was approached by G20 leaders in February to present a report on the factors that shape the liability structure of corporates, focusing on the implications for financial stability. The multi-national finance body co-ordinated with the International Monetary Fund, Organisation for Economic Co-operation and Development, Bank for International Settlements, International Organisation of Securities Commissions and World Bank.

Though the change in levels is quite diverse, with non-financial corporate leverage to GDP declining in some countries and rising in others, the report raises the possibility of taking action to address the tax bias in favour of debt over equity and the potential benefits of reversing it. Any potential decisions would need to be implemented at a national level however.

“Policies that correct the tax bias favouring debt would reduce corporate demand for credit and help mitigate the risks from excessive corporate leverage,” the report states.

The report also highlights the increase in foreign currency corporate funding and looks at the use of macro-prudential tools, which banks could use to make sure that they don’t lend to overleveraged companies. 

It examines the steps that some countries have taken, particular emerging market economies, to put prudential limits on the amount of foreign currency exposures, citing how some corporates may have demanded to borrow in US dollar or euro because of the low interest rates. This could in turn increase their credit risk however.

“BIS research shows that since the global financial crisis, banks and bond investors have increased the outstanding US dollar credit to non-bank borrowers outside the US from $6 trillion to $9 trillion. This has the potential to create currency mismatches, which may increase financial stability concerns if a sufficient number of corporates are subject to such mismatches and if there is no natural hedge and financial instruments for hedging are not available”.

The report proposes that further work in 2016 could include more analysis on economic factors driving corporate liability decisions, whether financial stability risks arise, case studies on countries’ actions to address the debt-equity tax bias, and sharing country experiences on the use of macro-prudential tools to counter these risks.

The FSB secretariat is located in Basel, Switzerland, and hosted by the Bank for International Settlements. Mark Carney, the governor of the Bank of England, is the FSB chair.