Emerging economies more fragile because of companies' large debt loads, which could quickly cause trouble to banking systems in crisis; debt at risk higher now than in period following 2008 collapse of Lehman Brothers: IMF

Cindy Allen

WASHINGTON , April 9, 2014 (Thomson Reuters Corp.) – Large debt piles at companies are rendering emerging economies more fragile because they could quickly transmit trouble to banking systems in a crisis, the International Monetary Fund said on Wednesday.

Debt at risk of not being repaid by companies that have already borrowed heavily could increase to $740 billion, or 35 percent of the total, the Fund found in a model test simulating a severe crisis.

"Debt at risk ... is even higher now than in the period following the September 2008 collapse of Lehman Brothers, and it is well above pre-crisis levels in Asia and in emerging Europe, the Middle East, and Africa," the IMF said in its Global Financial Stability Report.

The study, which comes out twice a year, described a number of threats to the global economy as countries recover from the credit crisis and aim to wean themselves from the cheap cash central banks have pumped into their economies.

The share of weak firms after the shocks was the highest in Argentina, Turkey, India and Brazil, where they could account for more than half of all the firms, the IMF said, using a sample of 15 countries for its test run.

Banks in Hungary, India, Indonesia, Malaysia and South Africa had the lowest provisions for loan losses and might need to raise additional shareholder capital if their borrowers default on their loans, the report said.

Banks also depended too much on funding their business through short-term debt rather than deposits, particularly in Latin America and in emerging economies in Europe, a known risk in case of a sudden investor scare.

In the United States, companies have been able to issue debt at easier terms than in the past, with so-called covenant-lite and second-lien loans on the rise just as they were before the financial crisis. A usual risk premium of 30-35 basis points for covenant-lite loans had disappeared, the IMF said.

U.S. bank regulators issued guidelines to banks last year to limit their risk-taking for so-called leveraged loans - risky loans that pay a high yield and that are commonly used by private equity firms to finance acquisitions.

Another risk the IMF found was that more people were now invested in corporate bonds via mutual funds and exchange-traded funds. In the past, banks used to hold a high inventory of these bonds, but new rules now make that harder.

The IMF said the risk of a fire sale in credit markets is higher, because it is easier for retail investors to sell loans if something spooks them and they all decide to shed investments at the same time.

In the euro zone, it said, banks were still burdened by non-performing loans after the currency bloc's sovereign debt crisis. Policymakers should also find ways for companies to become less dependent on their banks for credit, the IMF said.

It called on officials to make it easier for life insurers and pension funds to lend to small- and mid-sized businesses that have a hard time securing credit from banks, and ease the way for firms with a poor credit rating to list bonds. (Reporting by Douwe Miedema; Editing by Andrea Ricci)

* All content is copyrighted by Industry Intelligence, or the original respective author or source. You may not recirculate, redistrubte or publish the analysis and presentation included in the service without Industry Intelligence's prior written consent. Please review our terms of use.