Wolfgang Bergthaler, Kenneth Kang, Yan Liu, and Dermot Monaghan/IMF
The global financial crisis has left a large private sector debt overhang and high levels of nonperforming loans (NPLs) in several European countries. Small and medium-sized enterprises (SMEs) represent a significant and weak segment of the nonfinancial corporate sector.
SMEs face a number of legal, financial, and regulatory challenges to restructuring that differ from those of larger corporates, such as a rigid and costly insolvency regime, a higher fixed cost to loan restructuring, and the lack of alternative sources of financing. Given SMEs’ large presence and close links to the banking system, addressing the SME loan problem in Europe will be critical for strengthening bank and corporate balance sheets and supporting a more robust and sustained recovery.
The European Union and its member states have taken a number of steps to support distressed SMEs, from insolvency reforms and strengthened banking supervision, to financial support, but given the high debt overhang and NPL levels, more is needed to accelerate the resolution of problem loans and assist viable but distressed SMEs.
Based on cross-country experience with distressed SMEs, a comprehensive strategy can help promote NPL resolution and restructuring in Europe. Such a strategy should include tighter regulation and supervision of banks’ NPL management, insolvency reform targeted at SMEs, a greater push for out-of-court workouts, and supportive macro policies. The aim should be to provide more cost-effective, efficient tools and to strengthen the incentives for restructuring and resolution. Moral hazard risks should be addressed by ensuring the speedy exit of nonviable SMEs:
? Building on recent insolvency reforms in many European countries, establishing simplified procedures for SMEs would reduce the cost and inefficiencies of SME restructuring. Insolvency regimes should close the gap with international best practices for rapid pre-pack approvals, “fresh start”/debt discharge, and debtor-in-possession financing. Active involvement of public creditors would support the restructuring of viable SMEs. Enforcement and foreclosure systems should be enhanced and made effective. Against the backdrop of a sound insolvency system, guidelines on loan workouts and the increased use of mediation would support more out-of-court debt restructuring.
? Following the completion of the European Central Bank’s comprehensive assessment, supervisors should ensure that banks are adequately capitalized and provisioned in a forward-looking manner to provide sufficient resources for case-specific resolution or restructuring. For SMEs in particular, proper collateral valuation is critical. For systemic cases where assessing SME viability is challenging, regulators may need to undertake a “triage” approach to separate nonviable SMEs for speedy liquidation from viable but distressed ones for more standardized loan restructuring and to force loss recognition through time-bound write-offs.
? Other supportive policies include removing tax and regulatory impediments to NPL resolution, improving SME financial reporting and disclosure, and expanding SMEs’ access to financing, such as through securitisation and active use of government support schemes.
