Part 1 of the article series dealt with the impact of the goods market shock on the financial sector, specifically on expected credit losses. In the second part the question was addressed as to how this will affect private households and what impetus can be expected from the demand perspective for a revival of the economy. This article focuses on the companies.

Profit, revenues and costs as model anchor points of the crisis

In economic theory, model statements are always made c.p. (ceteris paribus), i.e., other things being equal. This easily brings the guild of economists under suspicion of using formulas to express things that common sense also tells you. Thus, it is not surprising that a company’s revenues increase when the prices of the goods sold, their quantities, or both increase.

In our goods market shock scenario, we have the fact that revenues are falling. For companies, depending on the size of the reserves, it becomes difficult when E < K and thus G < 0. The company has to adjust in these cases and can either reduce labor costs or capital costs.

Reducing labor costs can be done by reducing labor costs or by reducing labor input. Since wage costs are linked to contractual and legal bases and are thus not flexible, the adjustment runs through labor input. Currently, short-time work offers an opportunity to do this, as impressively demonstrated by the current figures of over 10 million short-time workers. How long this effect will be “short-term” is not yet foreseeable at present. Accordingly, it cannot be ruled out that some short-time workers will become unemployed.

Massive impact of interest rate level on cost of capital

Economic theory defines the factor r as the “rental costs of capital”. This includes not only the market interest rate for borrowing, but also the opportunity cost of the owners’ capital tied up in the company. Since the 2008 financial crisis, which seamlessly turned into a sovereign debt crisis, interest rates have been approaching zero, with the active assistance of central banks. Based on the equation, this sounds good at first; the smaller r is, the greater the revenue. Is that so?

From an overall economic perspective, low interest rates have many negative effects. Present consumption is clearly favored over future consumption, and the incentive to save is small. However, low savings also mean low investment, or cause investment in less profitable areas, which leads to a misallocation of investment resources and reduces growth in the long term. It also encourages the formation of bubbles, as can currently be seen in real estate prices. Moreover, the redistributive effect in the direction of the richer income strata should not be underestimated.

For companies that extend credit, there is another danger. Low interest rates mean that companies remain in the market that would actually not even earn their cost of capital without the low interest rates. Even a slight rise in interest rates would lead these companies directly into insolvency. The term “zombies” is often used colloquially for these companies. These zombie companies form a community of fate with the public budgets, whose options for action are existentially tied to low interest rates due to the high stock of debt. Unlike the public sector, however, these companies cannot raise taxes.

Financial service providers under pressure to act

It is therefore essential for financial service providers to recognize how much credit exposure they have to zombies. The first step, however, is to recognize the zombies in the first place. Subsequently, one can turn to the question of how to restructure the loans of such a company in order to be able to control the exposure accordingly.

Steffen Egly has been working in IT consulting for over 20 years, predominantly with a technical focus on insurance and banking topics. His fields of activity are insurance portfolio management, accounting, provisioning, loans and impairment.

Steffen Egly

ADWEKO Consulting GmbH


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