Impact of COVID-19 on Irish enterprises has been sudden, large and uneven

• Direct fiscal supports have provided significant financial support to the sector and the broader economy, but challenges will remain for the most adversely affected SMEs
• After accounting for reported reductions in wage and non-wage costs, revenue shortfalls for 2020 are estimated between €10.3bn and €11.7bn across the SME sector, although these estimates are subject to significant uncertainty.
• In aggregate, these shortfalls can be met by a combination of utilisation of pre-existing cash reserves, draw-down of existing credit commitments, new borrowing, additional cost reductions or loss-sharing, or if necessary governmental non-wage grants, reliefs and guaranteed loans.

Today the Central Bank published a Financial Stability Note, written by Derek Lambert, Fergal McCann, John McQuinn, Samantha Myers and Fang Yao, entitled “SME finances, the pandemic, and the design of enterprise support policies”. The FSN estimates the likely losses that are being experienced in the SME sector over the whole of 2020 and discusses the potential supports that can meet these shortfalls.

Due to the nature of many of their business models, SMEs are likely to be facing considerable financial strain in the current pandemic relative to larger corporations and households. The uneven nature of the shock across sectors has become apparent, with firms in some sectors such as the accommodation and food sector continuing to report the largest falls in activity relative to pre-COVID-19 norms.

After accounting for reported reductions in wage and non-wage costs, revenue shortfalls for 2020 are estimated between €10.3bn and €11.7bn across the SME sector, although these estimates are subject to significant uncertainty. The authors note that the uncertain outlook and the use of firms’ survey responses during the pandemic contribute to this uncertainty in the estimates. In aggregate, these shortfalls can be met by a combination of utilisation of pre-existing cash reserves, draw-down of existing credit commitments, new borrowing, additional cost reductions or loss-sharing, or if necessary governmental non-wage grants, reliefs and guaranteed loans.

The FSN also presents a model of the financial distress of SMEs, based on their capacity to meet losses through cash holdings, or to service interest expenses during the shock. The model suggests that existing policy supports are likely to have mitigated SME financial distress in some cases, but challenges will remain. From a policy perspective many of the firms modelled as being in financial distress may be viable over the medium term. Additional firm-specific forbearance or restructuring may be required to allow such viable SMEs the opportunity to trade through the current disruption.

The FSN outlines considerations for designing policy responses to SME financial distress. Some enterprises entered the COVID-19 shock with unsustainable business models and during a typical downturn the closure of such companies can be seen as part of the overall process of economic restructuring and dynamism. However, identification of such firms is difficult given the nature of the COVID-19 shock.

Given the difficulties in distinguishing viable from unviable firms currently, policy measures may need to prioritise the protection and survival of firms in the short-run, to a greater degree than in normal times. Further, the aggregate importance of firms through their creditor, employee, supplier and customer relationships means that widespread liquidation at a time when typical market signals are functioning poorly is undesirable. Nonetheless, policymakers also need to prepare for the likelihood that some SMEs are unlikely to survive this shock.

On support options, the FSN reports that wage-based supports through the TWSS and EWSS will have provided over €5bn of direct fiscal support to SMEs by March 2021. Reporting that the revenue shortfalls estimated in the FSN have already accounted for wage reductions achieved by firms through these schemes. Outside of wage support, the Irish policy package to SMEs, as is the case in many developed economies, is weighted more towards loans than grants or equity currently.

The FSN highlights the risk that debt-based supports may have weak demand from firms wary of borrowing, may lead to debt overhang issues over the medium term and face implementation issues when channelled through lenders. They benefit however from lenders’ access to information and incentives to screen credit risk, in cases where banks retain appropriate levels of risk.

Direct fiscal supports, such as grants or tax or rate waivers, provide liquidity and support the economy but raise issues regarding costs, targeting and moral hazard. Relative to a guaranteed loan, where costs only arise as defaults occur, grant funding is far more expensive up-front for the taxpayer. One potential option for the State is to provide equity-like or “conditional grant” injections to SMEs which involve an element of clawback or potential return, lowering the cost of intervention relative to a direct grant.

As system-wide payment breaks for SME loans expire from September 2020, the Central Bank of Ireland is focused on ensuring that there is appropriate support for borrowers in distress and that lenders treat them fairly, through consistent processes, and in line with relevant codes and regulations. This will involve lenders engaging effectively with distressed borrowers to deliver appropriate and sustainable solutions and facilitate as many borrowers as practical to return to repaying their debt in a sustainable way while also recognising and prudently accounting for the level of distress in their books.

Notes

A library of Financial Stability Notes is available on the Central Bank’s website.