Either alternative could create problems — with defaults damaging the banks or others who have lent money or bought corporate bonds, and capital investment cuts or other spending reductions affecting the ailing economy.
The data were released ahead of IMF spring meetings, where the fate of the euro zone remains a central issue. The information presents a quandary. Although some corporations in Europe have taken on too much debt, small- and medium-size businesses are finding it hard to borrow, further impeding any economic rebound.
“The slump in Europe is worrisome,” said IMF chief economist Olivier Blanchard, who suggested that European banks be allowed to bundle loans to small businesses into marketable securities to encourage them to lend.
The region has been consumed for three years in a crisis revolving around debt, and it is reeling from the subsequent “fiscal consolidation,” as nations cut spending or raise taxes to stabilize finances.
The potential corporate debt crisis could unleash the same dynamic in the private sector, whose debts sometimes dwarf the size of the surrounding economy. The IMF, which studied a sample of Europe’s largest firms, said the situation is probably worse than its survey indicated, because the companies were among the region’s strongest.
Just like their government counterparts, euro-zone firms gorged on cheap money that the establishment of the currency union provided to countries such as Italy and Spain, and they are paying it back amid a recession.
“Firms in the euro area periphery have built a sizeable debt overhang during the credit boom, on the back of high profit expectations and easy credit conditions,” the IMF said in its latest Global Financial Stability Report. Larger firms may skirt the problem by selling unneeded assets, “but further reductions in operating costs, dividends and capital expenditures may also be required, posing additional risks to growth.”
The warning on corporate debt is only one of the problems the fund sees on the horizon for the world financial system, particularly Europe. Years into a crisis that early on identified the banking sector as a particular weakness, the euro zone has not adequately recapitalized its banks, forced them to restructure and shed weak loans, or finished work on what many consider a necessity: a banking union that would unify financial supervision and share the risks of bank failures.
In one startling statistic, the IMF said euro-zone banks were only about halfway through a process of “deleveraging” — or bringing their obligations more closely in line with their assets. The fund estimated that euro-zone financial institutions still need to cut $1.5 trillion from their books, an amount that may increasingly crimp local lending because some of the easier steps, such as pulling out of overseas operations, have been done.