Restarting the Economy: How can we cure the overleveraging problem of UK SMEs?


By Gabriele Sabato

Introduction

The COVID-19 pandemic has proved to be the perfect trigger to the current economic recession, but the global economy was already weak and debt levels were at an all-time high already at the end of 2019. Our way of living gave the virus a great help to spread quickly throughout the world. Governments responded slowly and in a fragmented way. Lockdown measures were introduced and lifted at different speed creating public confusion. These measures significantly altered the habits of the vast majority of the population affecting every aspect of our life. Millions of businesses had to stop their activity from one day to another as a state of emergency was increasingly imposed across the world. People grew scared and confused flooded by information which could not be distinguished from misinformation and fake news.

Governments had to work under immense pressure to “get the virus under control” with very limited information available, a growing state of fear from the public and extreme time strains. This mixture of time pressure and fear has become a recipe for economic disaster and mis-management in many European countries, adding to the already critical sanitary conditions created by the virus. Globally, the short-term solution for this unexpected and rare event has been government intervention and unprecedented state aid. In the UK, this has taken the shape of policies and schemes such as tax deferrals, furlough schemes and most noticeably for businesses, CBILS and BBLS.

What is Overleveraging?

In mid-March, the UK government launched the Coronavirus Business Interruption Loan Scheme (CBILS) followed by the Bounce Back Loan Scheme (BBLS) in mid-April. Both of these Government backed loan schemes made loans increasingly accessible to small and medium sized enterprises (SMEs) which had experienced a fall in cashflow and revenue as a result of the pandemic measures.

By loosening monetary policy and removing conditions and covenants controlling the emission of debt, SMEs could quickly access loans, and most importantly, see it as a viable solution to their COVID-19 related financial problems. However, this emission of government backed debt at such a large and prolonged scale in addition to the paralysation of the economy has created an ideal ecosystem for zombie SMEs to flourish. Zombie SMEs are generally defined as companies which ‘fail to generate enough revenue to make their interest payments on borrowings for three years sunning and have low valuations that suggest moribund prospects’. Through CBILS and BBLS as well as other furlough schemes and tax deferrals, many UK SMEs began significantly increasing their debt and went into the corporate equivalent of an induced coma, they were barely alive and had just enough to get by. Additionally, it created a narrative of “buckling down” and surviving in hope of a better tomorrow, as opposed to adaptation and survival.