Sarah Breeden, executive director for financial stability, strategy and risk with the Bank of England, says that because the financial system and the "real economy" are closely connected, it is important to monitor corporate debt, given its impact on the economy.
Breeden, who is a member of the Financial Policy Committee (FPC), spoke at the Insolvency Practitioners Association's April 27 conference, saying corporate debt's impact on the economy means the financial system can help spur long-term, productive investment and do more to support business investment, according to Bank of England.
"The FPC’s primary objective is to ensure the resilience of the UK financial system by detecting, monitoring, and -- where possible -- countering systemic risk," Breeden said during her speech. "These risks are often not contained within the financial system. As we saw at the onset of the pandemic, tight linkages between the financial system and the real economy mean that shocks emanating from one can transmit to the other."
She said the FPC closely monitors corporate debt, which "is an integral part of the functioning of the real economy" because it enables companies to fund investments and "smooth cash flows," but there are risks associated with the debt. Corporate debt can cause "spillovers" that can potentially upset the stability of the wider financial system, she added.
FPC has identified two avenues where that happens, such as when companies with too much debt have trouble paying it back, Breeden said. If they fail, losses can damage lenders, as well as the supply of credit to the economy in general. Another is that companies that carry more debt can cut investment and employment more than those with less debt, which took place during the global financial crisis. This behavior can make macroeconomic slumps worse, affecting corporate strength and damaging the lending market.
UK companies have faced challenges related to the COVID-19 pandemic, such as increased input prices "and a rapidly tightening financial environment," Breeden said, warning that "the end is not yet in sight." She cited predictions that economic growth will flatline for the next few years, adding that lenders could be affected if these challenges lead to business or other failures.
The FPC has observed signs of borrower resilience, with investment plans varying widely across firms. The Bank’s Decision Maker Panel (DMP) survey shows that companies above the 90th percentile of debt are expecting to cut their investment by almost 5 percentage points more over the course of this year in reaction to higher interest rates than firms below it, Breeden said.
"If firms cut back investment excessively, or if productive firms forego investment opportunities, the effects could be persistent," she said, according to the Bank of England website.