CORPORATE DEBT AND BUSINESS DYNAMISM

Second, banks were unable to monitor some of their clients, as on-site visits were not possible for an extended period of time. Around 80 per cent of the CEOs interviewed reported that their banks had been negatively affected by their loan officers’ inability to monitor clients during the pandemic (see Chart 4.9).

Third, banks were often unable to recover pledged assets, mostly owing to the temporary closure of courts during the pandemic and delays to court proceedings. Although there were 14 countries where courts did not close and 20 countries where remote hearings were an option (see Box 4.1), between 60 and 90 per cent of bank CEOs across the EBRD regions reported that their banks had been negatively affected by delays to court proceedings.

An important point in this regard is that banks were in a significantly healthier position at the onset of the pandemic than they had been at the start of the global financial crisis in 2008. The various policy interventions that had followed the financial crisis had helped to clean up banks’ balance sheets, with the result that banks were able to continue meeting firms’ funding needs when the pandemic hit.13 The fact that most banks had relatively strong capital positions at the onset of the pandemic might also have mitigated the risk of excessively lenient lending to zombie firms.

Relatively few CEOs were worried about increases in NPLs, reflecting the swift adoption of extensive policy support packages, as well as regulatory forbearance. Nearly half of all CEOs reported that their banks had voluntarily deferred loan repayments in anticipation of this measure being imposed by their governments, while around a quarter reported that payment deferrals had been imposed directly by the government (see Chart 4.1.1). According to a survey of law firms conducted by the EBRD’s Legal Transition Programme, forbearance in respect of loans (capital and interest repayments) was applied in 26 of the 33 economies surveyed, with all surveyed economies having introduced emergency banking regulations. In some economies, however, compliance with banking regulations was either partly or completely voluntary.

The scale of these support programmes has fuelled concerns about a possible increase in zombification – whereby weak firms are kept alive artificially using cheap credit, with uncertainty as to whether those loans will be repaid – as well as fraud. Such zombification could have negative consequences for post-pandemic recovery plans if labour and capital get tied up in struggling firms and moribund sectors. This section revisits those concerns using regression analysis based on firm-level data.

On average, firms that had been classified as vulnerable or zombies in 2019 (before the onset of the pandemic) were no more likely to increase their debt levels in 2020 than firms that had been classified as healthy. In other words, Covid-19 support programmes were not biased in favour of weak firms.

Regression analysis can also be used to link changes in firms’ debt in 2020 broken down by type of firm (healthy, vulnerable or a zombie based on 2019 accounts) with the number of supportive policy measures that were implemented in the early stages of the Covid-19 crisis in the economies where firms operate. In this analysis, the total number of supportive government policies is based on programmes in place as at April 2020, as documented in the EBRD’s Regional Economic Prospects. Such policies include payment holidays for loans, rent and utilities, wage subsidies, the deferral of tax payments and social security contributions, the provision of loan subsidies and credit guarantees, and the suspension of inspections and audits.

This analysis reveals that in countries that introduced a larger number of policy measures to help businesses, zombie firms saw their borrowing grow at a faster rate than healthy firms (see Chart 4.10), with zombies benefiting disproportionately from preferential loan schemes and accommodative credit conditions. Consequently, it may be too early to dismiss concerns about accommodative policies encouraging the proliferation of zombie firms.

Thus, undercapitalised banks can prolong economic slowdowns by continuing to lend to weaker firms that are on the verge of insolvency while withholding credit from healthy borrowers. The resulting economic weakness, in turn, prevents banks from rebuilding capital buffers. Prominent examples of such a vicious circle include Japan’s “lost decade” in the 1990s, the eurozone in the immediate aftermath of the global financial crisis of 2008-09 and India in 2016-19.15

Second, the inefficient resolution of financial difficulties or insolvency also plays a role.16 If restructuring struggling firms is costly and time-consuming or banks have limited influence over insolvency procedures, the restructuring route becomes less attractive for lenders relative to the evergreening of loans. In such an environment, a creditor may feel that the risk associated with evergreening is preferable to long, value-destroying court proceedings, which carry negative stigma for the debtor and may or may not lead to partial recovery of the creditor’s assets.17 Foreign-owned banks tend to be particularly sensitive to deficiencies in a local legal and institutional environment and may shy away from lending as creditor protection falls.18

Third, the type of bank lending relationship also matters. Some banks establish long-term relationships with firms, whereby they gain detailed information about their clients over time and leverage that competitive advantage. On the basis of those insights, they may take a long-term view of a firm’s prospects, opting to help it weather temporary financial shocks (although such bridge funding may come at a price, with higher interest rates being charged).19 While relationship-based lenders will also need to cut funding to firms that are not viable in the long term, they may be in a better position to distinguish between temporary and chronic difficulties when compared with transaction-based lenders (which make decisions on the basis of algorithms, maintaining a short-term focus).

Fourth, banks – especially state-owned ones – may be under political pressure to limit firm closures and prevent job losses.20

In order to shed light on the relative importance of these various mechanisms in the EBRD regions, this section combines information on firms’ finances taken from the Orbis database with detailed information on bank ownership, capital adequacy and lending techniques that was obtained as part of BEPS III (which covered 339 banks in economies across the EBRD regions). In particular, bank CEOs were asked how important relationship-based lending was to their business on a five-point scale ranging from “very unimportant” to “very important”. Banks that replied “very important” are regarded as relationship-based lenders, as opposed to transaction-based lenders.21

The data show that undercapitalised banks (those with a tier 1 capital adequacy ratio of less than 13.5 in 2019) are just as common among relationship-based banks as they are among transaction-based banks, indicating that the approach to lending is largely independent of the level of capitalisation. However, the prevalence of undercapitalised banks does vary by ownership type. While only 18 per cent of majority foreign-owned banks in the sample were undercapitalised, that figure rises to 29 per cent for privately owned domestic banks and 32 per cent for banks with majority state ownership.

First, undercapitalised banks and state-owned banks are much more likely to be the main lenders to zombie firms (see Chart 4.11). A firm whose main lender is undercapitalised is 0.8 per cent more likely to be a zombie than a firm that borrows from a highly capitalised bank (while the average likelihood of being a zombie across all firms is around 5 per cent). Similarly, the likelihood of a firm being a zombie increases by 2.9 per cent when its main lender is state-owned, as opposed to privately owned.

Second, a relationship-based bank is less likely to be the main lender to a financially vulnerable firm, with higher likelihoods being observed for undercapitalised, foreign and state-owned banks. A firm’s likelihood of being in this category is 1.3 per cent lower if its main lender is a relationship-based bank, but 6.3 per cent higher if its main lender is state-owned. Around 20 to 25 per cent of all firms in the EBRD sample are classified as financially vulnerable.

The following firm-level analysis looks at banks’ responses to deteriorations in firms’ health by linking changes in the logarithm of debt held by a particular firm to an indicator that captures deterioration in the firm’s financial indicators which results in it being reclassified as financially vulnerable or a zombie (having previously been healthy). The analysis uses Orbis data on more than 2 million firms across 12 economies in the EBRD regions for the period 2009-20. Firm fixed effects take into account unobservable firm-level characteristics (such as business contacts and management know-how) which could affect the evolution of credit, as well as country-sector-year and bank-year fixed effects capturing factors that affect a certain bank or industry at a particular point in time. As such, the documented relationships do not simply reflect changes in firm-bank pairings whereby better-performing firms switch to working with better-performing banks.

The analysis reveals that when a healthy firm becomes vulnerable its subsequent ability to borrow depends strongly on the type of bank that it borrows from. For a firm whose main lender is a well-capitalised, privately owned domestic bank that adopts a transaction-based approach (the most common scenario in the data), no statistically significant change in debt levels is observed. If the firm’s main lender is an undercapitalised bank, its borrowing increases by an average of 9.4 per cent when its financial health deteriorates (relative to a firm whose main lender is a well-capitalised, privately owned domestic bank; see Chart 4.12). Similar average differentials are estimated for a relationship-based bank (11.4 per cent) and a state-owned bank (7.6 per cent). In contrast, this differential is negative for firms whose main lender is a foreign bank, with stocks of debt falling when firms become financially vulnerable.

When a healthy firm becomes a zombie, its stock of debt increases by an average of 22 per cent if its main lender is a well-capitalised, privately owned, transaction-based domestic bank. That same firm will, on average, see its debt increase by an additional 3.3 percentage points if its main lender is undercapitalised, by 4.9 percentage points more if its main lender is a relationship-based bank, and by 8 percentage points more if that lender is a state-owned bank.

Lending to financially vulnerable firms may also be dependent on the local institutional environment. In order to account for this, the analysis is conducted separately using samples of countries with strong and weak insolvency procedures as reflected in the World Bank’s Resolving Insolvency Indicator, which estimates, by means of a case study, the time, cost and outcome of – primarily liquidation-type – insolvency proceedings involving domestic entities in individual countries.24

This analysis indicates that zombie firms tend to increase their borrowing by more in settings with less efficient insolvency regimes – for instance, where creditors’ expected recovery rates for distressed assets are lower, where commencement of insolvency proceedings takes a long time, or where creditors’ participation in insolvency proceedings is limited. When a healthy firm becomes a zombie, it will increase its borrowing by an average of 29 per cent where the insolvency regime is weak – as opposed to 19 per cent where the regime is strong – if its main lender is a well-capitalised, privately owned, transaction-based domestic bank (see Chart 4.13). Other banks, including foreign-owned banks, also lend more to firms that become zombies when insolvency frameworks are weak.

Second, zombie firms make it harder for financially healthy firms to access credit (via a “crowding-out effect”), as capital-constrained banks that evergreen loans to zombies have less scope to lend to healthy firms.26 Squeezed margins, as described above, may further impair firms’ ability to access external funding.

In order to illustrate these channels, the analysis that follows uses a firm-level regression framework which relates annual revenue, investment rates (proxied by percentage changes in fixed assets relative to the previous year’s stock of fixed assets) and employment to a firm’s status as a healthy firm, as well as the asset-weighted prevalence of financially vulnerable and zombie firms in the same sector. Specifications control for healthy firms’ past stocks of debt and include firm and country-sector-year fixed effects, which take into account industry-specific trends, as well as firm-level characteristics that remain unchanged over time.

This analysis reveals that the presence of zombie firms is more harmful to healthy firms than the presence of other vulnerable firms, especially when it comes to investment and employment. The annual investment rate of a healthy firm will, on average, be 2 percentage points stronger than that of a vulnerable firm or a zombie if it operates in a sector with no zombie firms but an average number of vulnerable firms (see Chart 4.14). This differential drops to 1.4 percentage points when zombie firms account for 20 per cent of the sector on an asset-weighted basis. This is a sizeable effect, given that the average annual investment rate in the sample is 6 per cent. A similar trend can be observed for average annual employment changes (see Chart 4.14). Spillover patterns are similar, although somewhat weaker, in the presence of greater numbers of financially vulnerable firms with an average number of zombie firms.

Moreover, the analysis also reveals that such spillover effects are greater in the presence of state-owned zombies. On average, a healthy firm’s revenue will be around 13 per cent higher than that of a vulnerable firm in the absence of any zombies but with an average number of vulnerable firms in its sector. If such a firm finds itself in a sector where privately owned zombies account for 20 per cent of total assets, that differential drops by half a percentage point. However, in a sector where state-owned zombies make up the same proportion of total assets, the differential drops by 2 percentage points to 11 per cent (see Chart 4.15).

Upstream spillovers occur when credit market and other distortions cause a demand shock for suppliers providing inputs to a firm. If zombie firms become more prevalent in a sector that a business typically sells its products to, this will create uncertainty about future demand for the business’s output and may prompt it to scale back its investment or operations. In the case of indirect exporters, which use intermediaries in other sectors to sell their products abroad, financial trouble for customers may also mean losing access to international markets.

The analysis that follows captures such vertical spillovers by using Eurostat’s supply, use and input-output tables to account for the presence of vulnerable firms and zombies along the supply chain. An input-output matrix represents the linkages between different sectors of an economy – recording, for instance, how many of the inputs that a sector uses for production come from each of the other sectors. These input coefficients are used as weights to calculate the prevalence of vulnerable firms and zombies among a business’s potential suppliers (that is to say, among firms operating in upstream industries). Likewise, this information is also used to calculate the prevalence of vulnerable firms and zombies among a business’s potential customers or off-takers (that is to say, among firms operating in downstream industries).

The analysis provides strong evidence of negative spillovers – both downstream and upstream – resulting from the presence of zombie firms in the supply chain. These spillovers can be observed for revenue growth, investment rates and employment (see Chart 4.16). In fact, if zombie firms are sufficiently prevalent in either downstream or upstream sectors – if they account for more than 20 per cent of total assets – that is predicted to result in negative investment rates and employment growth for affected healthy firms. No such spillovers arise in the presence of vulnerable firms that are not zombies, highlighting the distortionary effect that subsidised credit has on the allocation of resources within the economy.

The estimates indicate that the presence of zombie firms is slightly more harmful among customers than it is among suppliers. On average, a healthy firm that sees zombie firms’ share of its off-takers rise from zero to 20 per cent will see its annual investment rate fall by 3 percentage points, while its annual employment will fall by an average of 4 per cent (see Chart 4.16).

Thus, zombie firms have more of an impact via vertical spillovers (that is to say, via supply chains) than via horizontal spillovers (that is to say, via spillovers within a given sector).

Second, banks need to have sufficient capacity to monitor the financial health of borrowers and make greater use of expert judgement to identify firms in financial distress. For instance, large-scale on-site inspections of the credit portfolios of several Portuguese banks in 2012 and 2013 made it less likely that those banks would refinance zombie firms, with the banks immediately triggering those firms’ default instead.29

Third, banks can establish dedicated workout units to resolve distressed loans – which should be independent of loan origination activities, as recommended by the European Banking Authority (EBA).30 This can prevent conflicts of interest between the team that originates loans and the team that is engaged in corporate recovery. Staff and management involved in workout activities should be given clear individual or team goals and incentives as part of an operational plan geared towards achieving an agreed target of reducing exposure to distressed borrowers. Having a dedicated workout unit can also ensure that the resolution of NPLs is handled by expert staff with specialist skills. Banks should take account of the specificities of their exposure to distressed borrowers (retail, SMEs or larger firms) and the particular types of collateral held when creating such workout units. Where overlaps between workout units and loan origination teams are unavoidable, a bank’s internal controls should ensure that any potential conflicts of interest are sufficiently mitigated.

Measures to improve the efficiency of insolvency procedures include electronic filing and case management systems, virtual court hearings and creditors’ meetings, and out-of-court or hybrid solutions.32 All economies in the EBRD regions allow for court-supervised reorganisation, but hybrid procedures where part of the process is conducted out-of-court are only available in half of them, and private workouts (consensual financial restructuring based on contracts) are not common.33 In private workouts, debtors and major financial creditors negotiate directly. In a hybrid approach, similar negotiations take place, but the court typically confirms any majority creditor agreement and a court order ensures that such an agreement is binding on all creditors. Out-of-court and hybrid approaches are a key feature of the insolvency landscape in developed markets and can also be particularly beneficial in countries with limited fiscal space and less effective insolvency systems.34

Within the European Union, further harmonisation of insolvency frameworks (as foreseen under the action plan for the capital markets union) and restructuring schemes have the potential to be of great benefit. For instance, the EU directive on preventive restructuring frameworks offers the possibility of implementing hybrid or out-of-court debt restructuring in order to prevent a “hold-out” creditor or class of creditors from blocking a reasonable restructuring plan, subject to certain protections.

It is important to note, however, that insolvency legislation and efficient restructuring are not, on their own, sufficient to prevent lending to zombie firms. For example, the new insolvency law that was introduced in India in 2016 had a limited impact on lending to such firms because of the prevalence of poorly capitalised and state-owned banks.35 As this chapter has found, state-owned banks are more likely than privately owned banks to engage in lending to financially vulnerable firms and zombies, especially if those firms are themselves state-owned. The removal of moratoria on debt enforcement and insolvency for state-owned firms, and the use of insolvency procedures for insolvent state-owned enterprises, are therefore essential in order to improve the governance of those firms in the longer term.

Banks’ balance sheets need to remain well capitalised in order to help fund a strong economic recovery. To this end, contingency planning may include the use of credit-servicing companies to support the resolution of NPLs. Debt restructuring schemes that make use of the informational advantages and skills of investors in distressed debt can be particularly beneficial. Such investors may be more motivated than banks to turn a distressed business around and sell it as a going concern, rather than liquidating it on a piecemeal basis.

While many businesses have burned through their equity in a bid to survive the Covid-19 pandemic, government support has focused heavily on liquidity support via loans. As loan support schemes and credit guarantees are phased out, they may need to be complemented or replaced with measures that promote the use of equity or equity-like instruments (such as debt-for-equity swaps in jurisdictions where insolvency law permits it). This can help to reduce the debt burden on businesses that are already overleveraged but otherwise viable, while giving a bank creditor a potential future upside if the business is successfully restructured. Equity injections can also help where companies that are on the verge of becoming zombie firms require costly restructuring and fresh resources in order to turn them around.

The use of banking regulations to introduce forbearance measures was an important indirect means of preventing mass insolvencies, with such measures including full or partial relief from the repayment of loan principal and capitalisation of interest. Adapting banking regulations in order to provide relief to borrowers was, in many countries, faster than amending insolvency legislation through a formal parliamentary process, with many changes to national banking rules coming in March and April 2020 in the early stages of the pandemic.

Data from the recent BEPS III survey show that almost all respondent banks (98 per cent) allowed at least some existing SME clients to temporarily defer repayment in response to Covid-19. More than 65 per cent of banks implemented such measures voluntarily – either completely voluntarily, or voluntarily in the first instance before deferrals were mandated by the government. Another 27 per cent of surveyed banks reported that the temporary deferral of repayment had been imposed on them by the government (see Chart 4.1.1).

Respondents in countries that did not introduce emergency insolvency measures indicated either that insolvency was not a priority for policymakers or that the legislative process was inefficient. Countries reacted at different speeds to the Covid-19 pandemic: the Czech Republic, Türkiye and Uzbekistan were relatively quick to respond, adopting emergency insolvency legislation in March and April 2020, whereas Armenia and Ukraine did not complete that process until the fourth quarter of 2020. In May 2022, emergency insolvency legislation was still in force in Armenia, Belarus, the Czech Republic, Hungary, Latvia, Lithuania, Poland and Romania, showing the lingering effects of the pandemic.

A few countries, such as Hungary and Poland, made substantial changes to insolvency legislation as part of their emergency measures. Poland, for example, introduced a new simplified procedure for the reorganisation of businesses, which proved to be highly popular. Of the 18 countries that adopted emergency bankruptcy legislation of some kind, eight (Lithuania, North Macedonia, Romania, Russia, the Slovak Republic, Slovenia, Ukraine and Uzbekistan) imposed temporary bans preventing creditors from filing for a debtor’s insolvency, while seven (the Czech Republic, Latvia, Lithuania, Poland, Romania, Russia and Slovenia) suspended the debtor’s obligation to file for insolvency. In many other countries, such suspensions were not necessary, since – unlike in western Europe – firms’ directors did not have a statutory duty to file for insolvency.

In some countries, court closures removed the need to legislate for temporary restrictions on the insolvency of creditors (or relax directors’ statutory obligation to file for insolvency in countries where this was applicable). Court closures were seen in 25 of the surveyed economies. In 20 countries, this was a direct legal requirement, but in five economies (Albania, Bosnia and Herzegovina, Kazakhstan, the Kyrgyz Republic and Mongolia) court closures were an indirect result of other social distancing measures or stemmed from the relevant court exercising its discretion to close its courtrooms or postpone hearings. In economies where this was a legal requirement, the average length of such a suspension was two months. However, the duration of court closures varied considerably, and in Greece the suspension of courts’ operations lasted a full 16 months. In some countries (such as the Slovak Republic and Slovenia) courts were able to hear urgent matters on an exceptional basis, despite the closure.

Seventy-four per cent of all banks surveyed in the context of BEPS III (which covered all of the EBRD regions, plus Belarus and Russia) reported that courts’ enforcement of debt recovery had been negatively affected by their temporary closure or suspension, or the increased delays to court proceedings. Of those banks, almost a quarter indicated that the temporary closure or suspension of courts had a very negative or extremely negative effect on their ability to recover pledged assets.

Given the economic importance of insolvency regimes, the EBRD’s Legal Transition Programme recently carried out an in-depth assessment of those frameworks in a wide range of economies across the EBRD regions, plus Belarus and Russia. That assessment measured the availability, effectiveness and extensiveness of national insolvency procedures aimed at reorganising insolvent or financially distressed businesses. It covered all of the main measures that could be used to rescue a business, including temporary moratoria on creditor action (to provide breathing space for restructuring negotiations) and “cram down” provisions (which bind a dissenting minority of creditors to a plan that has majority creditor and/or court approval). The assessment reviewed national legislation and practices using a questionnaire that was circulated to law firms, banks and judicial representatives between September and November 2020.37 A total of 457 respondents completed that questionnaire.38

On the basis of this information, countries were scored on a scale of 0 to 100, focusing on five specific areas of interest: a country’s general approach to the reorganisation of businesses; the planning and initial stages of the reorganisation procedure; the reorganisation plan; the approval phase of the reorganisation; and other relevant aspects. Countries also received a data transparency bonus of up to 10 points for publishing clear and comprehensive data on insolvency proceedings in general (including business reorganisation proceedings). Thus, the total assessment score had a possible range of 0 to 110.

First and foremost, the assessment showed that most EBRD economies still need stronger insolvency frameworks when it comes to the reorganisation of businesses. On a scale of 0 to 110, those economies only averaged 64 in terms of the strength of their legal, institutional and regulatory frameworks for the rescue of businesses, with scores ranging from 85 in Greece to just 38 in Lebanon (see Chart 4.2.1). Poland, Lithuania, Romania and Kosovo were the other top performers in terms of overall scores.

Second, the assessment reveals a significant data gap when it comes to insolvency. Only six of the economies covered by the assessment (Belarus, Greece, Latvia, Russia, the Slovak Republic and Slovenia) currently have a centralised electronic insolvency register. Much of the insolvency data collected in other countries is incomplete or out of date, which tends to reduce transparency for creditors, debtors and other stakeholders. The recent EU directive on preventive restructuring frameworks requires EU member states to collect certain insolvency data in the future and will help to narrow that data gap in those countries.39

Third, many countries have not invested sufficiently in insolvency regulation. In the majority of EBRD economies, a government ministry (usually the ministry of justice) oversees the insolvency framework. There are only five countries with a dedicated state agency or government department responsible for insolvency (Albania, the Kyrgyz Republic, Latvia, Serbia and Uzbekistan). Moreover, commercial insolvency proceedings are often overseen by general civil courts, which limits the development of judicial expertise in this highly specialist area. Only 16 of the economies covered by the assessment have commercial courts or departments specialising in insolvency cases, with Armenia the only country to have a dedicated insolvency court.

Fourth, in some economies secured creditors do not participate fully in national insolvency procedures aimed at reorganising businesses. In 18 economies, there is at least one reorganisation procedure where secured creditors are not fully bound by the procedure, often because they retain certain veto rights. In eight of those economies – Armenia, Azerbaijan, Bosnia and Herzegovina, Croatia, Egypt, Estonia, North Macedonia, and the West Bank and Gaza – secured creditors are prevented from participating in some (but not all) reorganisation procedures, being required to either relinquish their security to vote on a reorganisation plan or restrict their participation and voting on a plan to the unsecured portion of their claims. And in three economies – the Kyrgyz Republic, Lebanon and Turkmenistan – that restriction applies to all reorganisation procedures. This can jeopardise a successful outcome, since secured creditors are not signatories to the reorganisation plan and can enforce their security following the expiry of any statutory moratorium or stay on creditor action.

Fifth, while insolvency procedures aimed at reorganising businesses should be efficient and time limited to improve the chances of a successful outcome, respondents completing the questionnaire reported long average durations. While stakeholders in Estonia, Latvia, Lithuania, Jordan and Romania reported average durations of three to six months, proceedings tend to last more than a year in Bosnia and Herzegovina, Croatia, Georgia, the Kyrgyz Republic, Morocco, Tunisia and Türkiye. Furthermore, there is also a general perception that business reorganisation can be misused in order to delay inevitable liquidation-type procedures. In most jurisdictions, the court will order a statutory moratorium or stay, preventing any new or ongoing proceedings or actions by creditors against the debtor business from going ahead for the duration of the procedure, in order to support any reorganisation of the business. Thus, long average durations can significantly affect creditors’ rights and recoveries.

In their survey responses, firms pointed to the need for social security exemptions, tax deferrals and salary subsidies. Nearly a quarter of respondent firms in the EBRD regions reported that they needed access to loans and credit guarantees, while almost 20 per cent of businesses (including 40 per cent of firms in Türkiye) cited a need to defer loan repayments.

By March 2022, 29 per cent of the small firms surveyed had received government support in response to the pandemic: 15 per cent had received non-repayable grants or subsidies, while almost 10 per cent had received extra credit or been granted payment deferrals as part of government programmes. Government interventions had often made it much easier for SMEs to obtain bank credit, with the percentage of businesses with bank loans rising by a third between December 2019 and May 2020. In August 2020, the percentage of businesses with loans from financial institutions peaked at 29 per cent. That 2020 spike in access to credit was driven largely by firms in the southern and eastern Mediterranean (SEMED) and Türkiye, where levels of access to finance approached the levels seen in advanced EU economies.

In central Europe and the Baltic states (CEB) and advanced EU economies, the impact of government support packages was relatively short-lived, however (see Chart 4.3.1). After increasing markedly in 2020, the percentage of SMEs with a bank loan was back to – or even below – pre-pandemic levels by 2021, with government programmes in those regions mainly acting as short-term bridge financing to help firms weather the initial period of social distancing. Once that period had passed, many businesses started paying back business support loans. By the end of March 2022, over 85 per cent of borrowers under the United Kingdom’s Covid-19 loan guarantee schemes were making monthly repayments as scheduled or had fully repaid the relevant loans.40

Overall, national policies targeting SMEs’ access to funding appear to have been effective in preventing declines in employment: in economies where larger percentages of firms received government support (according to the survey), fewer firms had to make staff redundant (see Chart 4.3.2). In Lithuania and Poland, for instance, as many as half of all businesses surveyed received government support in response to the pandemic, and no more than 14 per cent of firms had to lay off staff. This effect is even stronger where government support was in the form of extra credit or temporary deferral of payment. In advanced EU economies, government support measures were similarly essential in providing liquidity to businesses and stabilising the economy.41

While more flexible lending dampened negative employment shocks during the pandemic, the overindebtedness of some firms is posing its own challenges. A firm-level phone survey that was conducted by the EBRD in 15 economies in the EBRD regions in May and June 2022 (see Box 3.3) indicated that many businesses were struggling with their debt obligations. Over a third of respondents reported that their outstanding debt had made it difficult to borrow more to finance new investment. A total of 63 per cent of firms in the SEMED region and Türkiye reported that new investment was being restricted (see Chart 4.3.3), compared with around 25 per cent in central Europe and south-eastern Europe (SEE).

Businesses had coped with financial hardship caused by the pandemic in a variety of ways – for example, by applying to restructure their liabilities (20 per cent of firms) or seeking equity recapitalisation (10 per cent of firms). In addition, 10 per cent of the firms surveyed were behind on their repayments to financial institutions.