The coronavirus credit binge

Payment holidays and government-backed loans are creating an enormous debt burden.

The covid-19 crisis has seen unprecedented disruption to businesses, forcing governments to take extraordinary measures including the suspension of debt repayments to try and prevent both corporates and individuals from going into default as the global economy virtually shut down.

Payment holidays have become a common sight in many countries, enabling borrowers to defer repayments on their debts for three months or more. For those who have seen their incomes disrupted or businesses that were forced to close their doors, a payment holiday is a lifeline to keep them afloat in these difficult times. But it is also a doubled-edged sword, as borrowers could simply be deferring their credit problems and facing more significant financial difficulty in the future.

As payment holidays only defer the payment to a later date, and do not pause and extend the amortisation schedule, those using them face higher payments in the future in order to catch up with their debt repayments. Interest also continues to accrue, which will increase the overall cost of the loans.

As Private Debt Investor reported earlier this week, there is growing alarm over the longer-term impact of payment holidays. A report by the Financial Stability Institute stated: “In this situation, loan balances will grow over time, owing to the negative amortisation from the deferral of interest payments, increasing risks for borrowers and banks.”

There’s another debt problem facing the economic recovery too, which is government-backed loans intended to help firms survive. Paul Shea, co-founder of UK-based lender Beechbrook Capital, recently warned that small and medium-sized enterprises face the prospect of becoming “zombie companies” if they end up overburdened by government-backed loans that they cannot repay. He argued that if markets aren’t able to step in and judge whether borrowers can survive or should be liquidated, the debt burden could ultimately be harmful to economic recovery.

While some commentators expect the economy to rapidly recover as coronavirus restrictions are lifted, if it does not, many borrowers may find their debt burdens are unsustainable. Covid-19 has seen an enormous credit binge, largely underwritten by governments, but eventually this money has to be repaid and the effects of high indebtedness could weigh on the economy for years to come.

Write to the author at john.b@peimedia.com