The number of insolvencies rose sharply during 2022 and reached new heights in March this year. While this has fuelled concerns about the UK corporate sector, the underlying reality is probably more benign.  

Much of the acceleration in insolvencies over the past 18 months appears to be the result of catching up after the covid pandemic. Indeed, we need to remember that insolvencies were artificially low during 2020-21, as specific policy measures were introduced to limit business failures – most notably the Corporate Insolvency and Governance Act 2020. Financial support such as the furlough scheme and cheap, state-guaranteed business loans probably helped some firms keep afloat for longer than they otherwise would have. Practical impediments such as court closures during lockdowns may have also been a factor.

Perhaps more importantly, the latest data for April has signalled some moderation in the number of insolvencies – there were 1,685, the lowest non-seasonally adjusted monthly rise since last February and 15.2% lower than the same month last year.

The correlation between insolvencies and economic growth is strongly negative. What’s more, there seems to be a minimal lag between changes in growth and insolvency rates, so with the economy having been flatlining for over a year, we would expect the insolvencies data to reflect much of this impact already.

Our calculations suggest a 1 percentage point increase in economic growth should reduce the number of insolvencies by around 1,200 per year. Our forecast of no growth in 2023 would be consistent with annual insolvencies this year of around 19,400. Our 2024 GDP growth forecast of 0.4% would be expected to see insolvencies drop to around 18,900.  These figures suggest insolvencies are likely to remain above their immediate pre-pandemic average of around 16,000 per year, but below the 2022 figure of 22,120 and their Global Financial Crisis peak of 24,035.

Corporates’ borrowing costs (through bank loans) correlate closely with moves in the Bank of England’s Bank Rate. However, our analysis suggests that interest rates are a less powerful determinant of insolvencies than economic growth – although the zero-rate era complicates statistical forecasts. In a more normal interest rate environment, our estimates suggest that a 1 percentage point rise in interest rates would be expected to increase the annual number of insolvencies by around 250.

Overall, this suggests that the corporate sector is less vulnerable to rising interest rates than might have been expected; however, once interest rate rises weigh on GDP this becomes more problematic. The cost of funding may have a greater impact on other aspects of corporate performance and behaviour, such as profitability and investment expenditure. 

UK corporate debt levels are at multi-decade lows as a percentage of nominal GDP: 17.6% in Q4 2022, just over half the level of the 2009 peak and down from a more recent pandemic lockdown high of 23.8%, when firms were tapping cheap government-backed liquidity facilities. This reduced debt stock leaves the sector less vulnerable to rising interest rates and tightening financial conditions. 

The theme of reduced debt exposure is reinforced by recent lending trends. The UK corporate sector has made average monthly net debt repayments of £2.4 billion since the beginning of 2022 – in contrast, there was average monthly net borrowing of £2.0 billion in 2019. The ONS’s latest high-frequency Business Insights and Conditions Survey (BICS) suggests that 46% of businesses have no debt obligations, up from around 40% in late 2021.

Meanwhile, the Bank of England’s quarterly Credit Conditions Survey – a survey of lenders – shows that overall credit availability for corporates, actual and expected, has not changed dramatically in recent quarters. 

The ONS’s high-frequency BICS data reflect a somewhat polarised corporate sector in terms of cash buffers, with rising proportions of firms reporting less than one month of cash reserves and more than six months. This suggests that, while the corporate sector as a whole is in reasonable financial health, there are pockets of potentially more immediate stress.

The BICS also suggests that firms’ concerns about insolvency are diminishing, although it remains to be seen if this is a case of complacency. Almost half of respondents judged themselves to be under ‘no risk’ of insolvency, with a further 43% deeming the risk to be ‘low’.

It’s important to bear in mind that the response rates to these surveys are low (around 25%), so they may not be wholly representative of wider conditions – firms in financial difficulty are unlikely to prioritise responding to a voluntary survey. As might be expected, small businesses are experiencing the greatest financial pressure, with higher reported and expected defaults.

Part of the explanation for the relatively benign indicators of corporate financial stress may be the persistent weakness in UK capex trends – investment and, by extension, borrowing have been very restrained in recent years. This is likely to be more relevant for larger firms, which tend to account for a larger proportion of investment expenditure. 

The CBI quarterly survey shows that financing costs are becoming more significant in holding back investment spending, although this remains a far less important factor than uncertainty about future demand, concerns about low returns and labour shortages.

All this is not to give the impression that UK corporates have reached the sunlit uplands. Sluggish economic growth, a depleted capital stock, labour supply impediments and rising borrowing costs represent significant challenges and we expect insolvencies to remain above pre-pandemic averages both this year and next. 

However, our calculations suggest that the growth and interest rate outlooks are not expected to result in a scorched-earth wave of destruction. Corporate insolvencies are expected to be materially lower than during both the 2008 Global Financial Crisis and the early-1990s recession. 

Ironically, perhaps, one of the UK’s most glaring macroeconomic deficiencies – persistently low levels of corporate capex – also means that corporate debt levels are low and sensitivity to rising borrowing costs is reduced. Of course, companies surviving is not the same thing as companies thriving – the UK’s perennial productivity challenge persists.

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