VoxEU Column COVID-19 Europe's nations and regions

Coronavirus credit support: Don’t let liquidity lifelines become a golden noose

As lockdown measures continue, or are relaxed only gradually, many small businesses continue to experience significantly reduced turnover. This column reports on a firm-level analysis across 16 emerging markets, and three Western European comparator countries, in order to gauge the potential risks associated with debt-driven COVID-19 support. The overall goal is to prevent a wave of bankruptcies that could break valuable relationships between firms and their suppliers and employees. However, liquidity support in the form of additional bank lending may create debt-overhang problems in the future and therefore requires careful targeting.

Over the past decade, corporate leverage has increased considerably in many developing countries and emerging markets, often exacerbating financial fragility (Alfaro et al. 2019). Policymakers who aim to alleviate corporate cash shortages during the COVID-19 pandemic therefore need to avoid overloading financially vulnerable firms with more debt. This risk is real given that the most popular method of COVID-19 support to SMEs has been to provide these firms with more loans. To gauge the potential risks associated with debt-driven COVID-19 support, this column reports on a firm-level analysis across 16 emerging markets, and three Western European comparator countries. Our objective is to understand where ‘small and medium-sized enterprises’ (SMEs) are most in need of cash and liquidity and, second, where these firms still have room on their balance sheet to take on more debt. Where there is little or no such room, further bank lending may come at the risk of a structural weakening of banks’ balance sheets (Galí 2020).

Our analysis is based on a firm-level dataset that combines information from surveys conducted as part of the latest round of the EBRD-EIB-World Bank Enterprise Surveys (with data from Orbis). We use these data to estimate regression models of firms’ optimal capital structure or leverage (defined as formal debt to total assets) and, separately, their cash holdings (defined as cash and cash equivalents to total assets). The models clarify how firms’ pre-COVID-19 capital structures and cash buffers can be explained by basic firm characteristics such as their size, profitability, asset tangibility, turnover variability, and industry.

Using these simple models, we then calculate for each country how much the average small business’s cash buffer falls short of (or exceeds) the predicted cash buffer. Likewise, we measure the available capacity for additional debt of the average SME (firms with 250 or fewer employees) in each country. Figure 1 summarises these calculations. The horizontal axis shows how SME cash holdings in countries such as Croatia, Lithuania, Morocco, Serbia, Slovenia, and Ukraine fall short of the predicted value by between 3-7% of total assets. In contrast, the average small business in Bulgaria, Czech Republic, Latvia, Montenegro, and Slovak Republic has greater than predicted cash buffers.

Figure 1 Excess leverage and cash holdings of the average small business

Notes: The chart reports weighted averages.
Source: Authors’ calculations based on data from ES and Orbis.

The vertical axis of figure 1 shows where small firms (on average) still have the capacity to borrow more. For instance, this is the case in countries like Lithuania, Morocco, and Ukraine (countries where SMEs seem to have an urgent need for more liquidity), as well as in Bulgaria, Montenegro, and Slovak Republic (countries with excess cash). In contrast, in countries such as Bosnia and Herzegovina, Croatia, and Slovenia (as well as Portugal,) there appears to be (on average) little room for more debt. It should be noted that even the average SME in many of these countries appears to have had limited liquidity buffers at the time pandemic first broke out.

Next, using the same models, we calculate for each country the proportion of SMEs that operate with lower than predicted cash buffers as well as the proportion of SMEs that entered the COVID-19 pandemic with relatively ample cash reserves. Likewise, for each country we calculate the proportion of SMEs that had little room for additional debt, and the proportion of SMEs that still appear in a position to absorb more debt. Figure 2 summarises these results. More than 60% of SMEs in Morocco and Ukraine are both short on cash and have room to take on extra debt. In contrast, we again see high shares of small businesses in Bosnia and Herzegovina, Croatia, Serbia, and Slovenia that are short on cash but are already highly leveraged. Estonia and Poland are similar in that about a third of all SMEs are short on cash but already have borrowed a lot.

Figure 2 Distribution of small businesses by pre-Covid-19 debt and cash structure

Notes: The chart reports weighted shares
Source: Authors’ calculations based on data from ES and Orbis.

How long can small businesses survive with their existing cash buffers? As a rough indicator, we calculate the number of months that a small business can afford to pay its employees out of its existing cash reserves. We then plot the distribution of businesses by different ‘survival horizons’ in Chart 3. About half of all small businesses in Ukraine have cash reserves of less than one month’s wages. Only around 20% of Ukrainian SMEs have the liquidity to pay more than six months’ wages. Similarly, most small businesses in Montenegro, Russia, Lithuania, and Slovenia were likely to run out of cash reserves to pay their workers in less than two months.

Where can credit access relieve liquidity constraints the most? Figure 3 also shows how the share of small businesses with liquidity constraints would change were they to ‘load up’ on debt to a level that our model would predict is normal (given their other firm characteristics). This shows, for instance, that additional lending to Ukrainian SMEs could decrease the share of businesses with cash buffers that only cover up to one month of wages from 50% to 20%.

Figure 3 Ability of cash reserves to pay labour costs

Notes: Weighted calculations
Source: Authors’ calculations based on data from ES and Orbis.

Policy implications

Our empirical analysis is rudimentary in the sense that it disregards certain firm- and country-specific determinants of corporate debt and cash buffers. Notwithstanding, the analysis provides a straightforward and micro-founded ‘traffic light system’. This can help diagnose in which countries firms’ needs for liquidity are most dire, and (as importantly) in which countries these temporary cash shortages can safely be alleviated through more debt funding. For instance, in countries like Bosnia and Herzegovina, Croatia, and Slovenia, there appear to be a relatively large number of  firms in need of liquidity but there are also many firms that are already highly indebted. In such countries, efforts to support cash-strapped firms may take the following into consideration:

  • Decisions about whether to alleviate cash shortages through additional bank lending should ideally continue to be based on a case-by-case assessment of individual firms’ debt capacity. This in turn requires a view on whether the business was performing well before the pandemic, or already had issues. Business exit remains an essential part of the process of creative destruction.
  • Where possible, lending programs should require participating banks to make full use of existing credit bureaus and registries to ensure a complete picture of total outstanding debt. This holds in particular for emerging markets with a history of episodes of excessive private sector borrowing, and where information sharing among lenders has proven beneficial (De Haas et al. 2020).
  • In countries where few firms have spare debt capacity, SMEs may be better served by government-sponsored initiatives to roll over existing debt rather than to provide fresh debt. This may include temporary debt moratoriums and loan-maturity extensions.
  • On a structural level, many emerging markets will need to gradually rebalance their financial systems towards a greater use of equity instruments and a reduced reliance on debt (EBRD 2015). In the short term, interesting proposals have been made for a European Pandemic Equity Fund (Boot et al. 2020). Such a fund would provide cash-strapped SMEs with cash flow injections in return for, for instance, a surcharge on future corporate tax payments. In the medium term, governments and (multi-)national development banks can play a proactive role in stimulating a public and private equity culture in emerging markets (for instance through improving research coverage and hence transparency of listed SMEs). As part of the COVID-19 response, financial resilience can further be rebuilt by selective equity investments in financially sound, high-growth, and innovative small businesses with strong management already in place. Lastly, in the long run, policy makers could structurally reduce tax-code favouritism towards debt (for instance, by giving firms equivalent tax benefits for equity and debt).


Alfaro, L, G Asis, A Chari and U Panizza (2019), “Corporate debt, firm size and financial fragility in emerging markets”, Journal of International Economics 118(C): 1-19.

Boot, A, E Carletti, H‐H Kotz, J P Krahnen, L Pelizzon and M Subrahmanyam (2020), "Corona and Financial Stability 4.0: Implementing a European Pandemic Equity Fund",, 25 April.

De Haas, R, M Millone and J Bos (2020), “Information sharing in a competitive microcredit market”, Journal of Money, Credit and Banking, forthcoming.

Didier, T, F Huneeus, M Larrain and S Schmukler (2020), "Hibernation: Keeping firms afloat during the COVID-19 crisis”,, 24 April.

EBRD (2015), Transition Report 2015-16: Rebalancing Finance, European Bank for Reconstruction and Development, London.

Galí (2020), “Helicopter money: The time is now”, in Baldwin, R and B Weder di Mauro (eds.) Mitigating the COVID Economic Crisis: Act Fast and Do Whatever It Takes, Book, CEPR Press.

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