The global private debt mountain has expanded over the past decade, with the world’s leverage now higher than pre-2008 levels. Barbara Pianese reports.
Debt and financing have a relevant role when it comes to growth and investment. But they can also pose a risk to financial stability if they become too high.
Global corporate debt has risen substantially over the past decade, both in advanced and emerging market economies, supported by low interest rates and easy access to global capital markets. The world’s leverage is currently at a higher level than pre-global financial (GFC) crisis peaks.
High levels of leverage could make firms vulnerable to shocks, especially in an environment of weak economic growth and higher interest rates. Since the GFC, many large corporations around the world have shifted toward leveraged loan and bond financing because commercial bank lending has been subdued.
Non-bank financial institutions (NBFIs) have been growing fast in the past decade, and now account for nearly 50% of global financial assets, according to the International Monetary Fund. NBFIs and traditional banks are also heavily interconnected.
Many corporates have used this debt to pay higher dividends and buy back shares, rather than for investment.
The economic rebound from the Covid-19 pandemic and the rise in inflation have helped reduce the mountain of debt as a percentage of gross domestic product (GDP). Nevertheless, global debt remained nearly 19% of GDP above pre-pandemic levels, as of the end of 2021.
In 2017, there was more than $110tn worth of private debt outstanding, calculates the Bank for International Settlements.
Corporates in some European and emerging markets, as well as Japan, operate at higher leverage levels. China’s debt, for example, makes up a third of global corporate debt. Major increases of leveraged corporate debt were recorded in most jurisdictions by firms operating in the consumer, industrials, basic materials, utilities and energy sectors.
In the US, low credit quality debt has increased substantially since 2015. The level of debt of the riskiest firms is now similar to the levels in 2006 and 2007, just before the GFC, according to a paper from the Organisation for Economic Co-operation and Development.
Methods to keep global leverage down include more cautious lending, reduced overspending, restructuring low-performing enterprises and writing down less-productive debt.
Governments could incentivise restructuring over liquidation and, where necessary, extend solvency support. Enhancing restructuring and insolvency mechanisms through dedicated out-of-court restructuring could also help. Policy-makers should also strengthen regulatory reporting of key data, making it clear how much risk firms are taking on from their borrowing or use of derivatives.
Corporate sector stress will affect the banking sector through increases in non-performing loans, as well as other investors in high-yield corporate bonds like insurance companies, pension funds and asset managers. Structured product markets, such as collateralised loan obligations, may also be impacted.
