Financial Stability Review – April 20254.3 Focus Topic: The Recent Increase in Company Insolvencies and its Implications for Financial Stability
The share of companies entering insolvency has risen sharply over the past couple of years to be at the top of the range observed in the 2010s, but on a cumulative basis remain slightly below their pre-pandemic trend. The rise has been due to challenging economic conditions and a catch-up effect from exceptionally low insolvencies during the pandemic. Financial stability risks, though, remain contained because most insolvent firms are small with little debt, many have a chance of recovery, and indirect effects on financial stability via job losses have been limited.
This Focus Topic examines the characteristics of firms that have recently entered insolvency, the factors that have caused them to become insolvent, and the implications for financial stability.
Insolvency is the most severe form of financial stress for a business and can occur for a variety of reasons.
Insolvency affects only a very small share of businesses in a typical year.1 A business is considered insolvent when it is no longer able to pay its debts when they fall due. In such a case, a third party is appointed to assess the financial position of the firm, and often takes control to manage the firm’s assets in the best interest of creditors. Insolvency can take various forms, including liquidation, voluntary administration, receivership and small business restructuring.2 Over the 15 years prior to the pandemic, only an average of 0.1 per cent of firms entered insolvency each quarter (Graph 4.3.1).3 By contrast, roughly 10 times as many firms exited by ceasing trade without actually entering insolvency.4
Insolvency can arise from economic conditions and/or business-specific reasons. Economic downturns, such as the 1990s recession and the global financial crisis, often drive the insolvency rate higher (Graph 4.3.1). Business-specific factors, such as poor strategic management or financial control, also play an important role (Graph 4.3.2).5 Firms citing economic conditions as a cause of insolvency also tend to cite other business-specific issues; this suggests that weak economic conditions exacerbate underlying issues with a firm’s business model or management.
Changes in policy and insolvency arrangements can also affect trends in insolvencies. For example, in the early 2000s the lowering of corporate insolvency costs led to an increase in the insolvency rate at the same time. More recently, a number of support measures introduced during the pandemic also had an effect on insolvencies (discussed below). The introduction of small business restructuring – a new process of restructuring debts – may also have slightly affected aggregate insolvencies since 2021.
While the pathway into insolvency varies, it typically follows an extended period of cashflow difficulty, leading to an inability to repay debts. Cash flow difficulties can stem from a fall in revenue, an increase in costs (including interest expenses), and/or pressure on margins. These shifts can originate from industry or business-specific developments (such as losing a key customer), or from the broader economic environment (such as weak aggregate demand or cost pressures). Firms may try to weather this period by drawing on their existing cash or equity buffers, and/or by accruing more debt with banks, non-bank lenders, other businesses via trade credit, or the Australian Taxation Office (ATO).
Pandemic support measures reduced the risk of widespread financial stress and economic damage, reducing insolvencies during this period.
Income support policies supported business cash flows and employment.6 By increasing businesses’ cash flows, the support measures reduced the share of businesses facing cash shortfalls and prevented many firms from failing during the pandemic.7
Changes to the insolvency framework allowed more businesses to continue trading than would otherwise have been the case. For example, the thresholds for owed amounts before creditors were able to issue a statutory demand for payment were temporarily increased.8 One ongoing reform involved the introduction of small business restructuring plans. This reform aimed to improve the survival rate of small firms in financial stress, and to simplify and reduce the costs associated with insolvency procedures.9
Flexibility in tax payments and lodgements also played a key role in keeping insolvencies low during the pandemic. The ATO is a creditor for many insolvent firms and introduced various relief measures during the pandemic (Graph 4.3.3, top panel).10 These included payment and lodgement deferrals and interest-free payment plans that helped some businesses in financial stress to continue trading. These arrangements resulted in some firms accruing larger debts with the ATO (Graph 4.3.3, bottom panel).11 Since 2022, the share of insolvent firms entering external administration with tax liabilities exceeding $250,000 has risen by more than 10 percentage points. Compared with pre-pandemic levels, total collectable debt from insolvent small businesses has more than doubled. This reflects not only the elevated level of insolvencies and the larger debt owed to the ATO, but also the resumption of ATO enforcement activities.12
Insolvencies have increased as pandemic support was removed and economic conditions became challenging.
Pandemic policies delayed the failure of some firms. On a cumulative basis, insolvencies fell below their pre-pandemic trend for an extended period and, despite increasing recently, have remained slightly below that trend (Graph 4.3.4). Direct cash transfers and precautionary saving helped most businesses accumulate substantial cash buffers through the pandemic period.13 While the pandemic support measures helped firms stay afloat longer, those with underlying issues – such as poor management or weak financial control – may still ultimately fail. Further, while many firms, particularly those with the lowest levels of profitability, saw temporary boosts to their profitability during the pandemic, some have struggled again in recent years, leading to insolvency regardless (Graph 4.3.5).14 This is evident in the age distribution of firms entering insolvency, with more older businesses failing in 2023 and 2024 than usual (Graph 4.3.6).15
In addition to the removal of pandemic support, rising costs, weak growth in demand and higher interest rates have also contributed to the increase in insolvencies. Insolvencies remained at record lows during 2022, as many businesses also benefited from a strong recovery in demand following the pandemic. However, a range of firms have since faced significant cash flow pressures given the economic environment and have had to cut costs. These pressures are likely to have been particularly acute for those also experiencing firm-specific issues.
Insolvencies have been highest in construction and hospitality, reflecting the interaction of industry-specific factors and economic conditions. Construction insolvencies increased sharply in 2023 due to supply-side challenges, including high input costs, delays arising from labour and materials shortages, and the prevalence of fixed-price contracts.16 Insolvencies have also risen sharply in industries exposed to discretionary spending, notably hospitality. Poor economic conditions were the most cited reason for failure among hospitality operators who entered insolvency in 2024. These firms are especially vulnerable to changes in demand, as they typically operate with slimmer profit margins and limited cash buffers.17
Risks to the financial system remain contained as most insolvent firms are small and carry little debt.
Higher insolvencies could pose risks to the financial system through several channels. The most direct risk is loan losses for lenders such as banks and non-banks. Insolvencies can also impact other types of creditors, such as suppliers reliant on trade credit. Indirect risks arise when firm failures are widespread and affected workers cannot secure employment elsewhere, which may result in some defaulting on their mortgages or other debt, and lead to a further worsening of economic conditions. Additionally, widespread business closures can trigger asset fire sales, potentially depressing asset prices.
However, these risks currently remain contained. More than three-quarters of recent insolvencies have been small businesses, defined as less than 20 employees (Graph 4.3.7).18 Additionally, an increasing share of insolvencies are now small business restructures – currently around 20 per cent. These businesses have small outstanding liabilities and a high recovery rate, with more than 90 per cent re-registering and resuming trade within three months of the insolvency appointment.
Banks have limited exposure to businesses that have entered insolvency in the recent period. Banks’ non-performing loan rates remain low and external administrator reports show that most companies entering insolvency have no outstanding secured debt (the type most likely to be owed to banks) (Graph 4.3.8, left panel).19 Moreover, liaison indicates that banks’ risk management practices further limit their exposure to these companies.20
Most companies that enter insolvency have unsecured debt, typically owed to suppliers, contractors, non-bank lenders and related parties of the business (Graph 4.3.8, right panel). Many of these unsecured creditors have incurred losses, with suppliers and contractors rarely recovering funds from external administrations, which accounts for a large share of total company insolvencies.21 Liaison indicates that non-banks have also incurred some losses from insolvencies, though these are small. Additionally, while the share of trade credit that is overdue has increased over the past couple of years, it remains around its historical average, even in industries experiencing elevated insolvency rates.
Job losses at insolvent companies have been limited, and most affected employees have quickly secured new employment. Most businesses entering insolvency have less than 20 employees (Graph 4.3.7). And more than 90 per cent of individuals who were working for an insolvent firm in the year leading up to the insolvency have been re-employed by another business within a few months or been retained. These individuals have been able to recover their pre-insolvency earnings within a year (Graph 4.3.9).22 This includes workers in those industries with higher rates of insolvency. However, there is a small share who do not find a new job within a year. Businesses that enter small business restructuring retain most of their workers, consistent with the vast majority continuing to trade.23
The risk of widespread asset fire sales has been limited as most businesses entering insolvency do not hold secured debt. Spillovers are also likely limited to businesses that held business-related assets. While conditions in commercial property markets – particularly offices – have been challenging in recent years, there is little evidence of financial stress among owners of commercial real estate. The risk of fire sales impairing market functioning is lower for other assets that are used as collateral for business loans – for example, cars and trucks – as these markets are typically deeper and more homogenous.24
Risks to the financial system are expected to remain contained even if insolvencies remain elevated.
The future path for insolvencies is highly dependent on how economic conditions evolve, though some factors will put upward pressure on the insolvency rate in the months ahead. Insolvencies are yet to return to the pre-pandemic trend in several industries, suggesting there may be more catch-up to come given the exceptionally low insolvencies during the pandemic. While cash flow pressures are expected to ease (see Chapter 2: Resilience of Australian Households and Businesses), this will not necessarily translate into a lower level of insolvencies in the near term due to the lag between entering financial stress and insolvency.
Nevertheless, risks to the financial system are expected to remain contained. Smaller firms continue to be more at risk of insolvency as they are more vulnerable to the current challenging conditions than larger firms.25 Should more medium- or large-sized businesses enter insolvency, lenders’ exposures would likely increase.
Endnotes
This analysis is limited to company insolvencies and excludes business-related personal insolvencies. Business-related personal insolvencies include insolvent individuals who have operated as sole traders, in partnerships or were directors in companies. These insolvencies have increased a little over the past couple of years, but this is from record lows during the pandemic, and they remain significantly below historical averages (see Chapter 2: Resilience of Australian Households and Businesses). 1
The Australian Securities and Investments Commission (ASIC) includes information on its website about the corporate insolvency framework and the processes involved with each type of insolvency. See, for example, ASIC (undated), ‘Insolvency’, available at <https://asic.gov.au/regulatory-resources/insolvency>. 2
Different measures of companies can be used to calculate insolvencies as a share of businesses, which is important to adjust for changes in the number of businesses over time and to understand the economic significance of the number of insolvencies. These measures include scaling company insolvencies by the number of registered companies or operating businesses. There is a difference in levels between the two measures reflecting how business entities are treated in each measure. A business may have multiple entities, each of which might have its own company registration and would be captured in the company registrations data. But only active and operating entities will be captured in the operating businesses measure. 3
It is important to note that a company insolvency is not the same as a company exit. Businesses may exit voluntarily if, for example, they are facing limited growth prospects, have a lack of access to credit, or for reasons unrelated to its financial position, such as the retirement of the owner. Typically, business exits are around 10 times higher than insolvencies in a given year. However, the implications of an exit for the financial system are more limited – a business choosing to exit will have repaid its creditors in full. Furthermore, entering insolvency does not always result in a company ceasing their activities – some companies in external administration will be sold as a going concern or will satisfy their creditors and regain control from external administrators. 4
Kenney, La Cava and Rodgers group causes of insolvency into three broad categories: 1. company-specific factors that vary with time, which are labelled ‘cyclical’ factors, such as profitability and leverage; 2. ‘structural’ company-specific factors that do not necessarily vary with time, such as whether the company is listed on the stock exchange or is a subsidiary of a parent company; and 3. external macroeconomic conditions, such as the state of the real economy. See Kenney R, G La Cava and D Rodgers (2016), ‘Why Do Companies Fail?’, RBA Research Discussion Paper No 2016-09. 5
Businesses were eligible for direct cash transfers from the federal and state governments, and the ATO changes that temporarily introduced flexibility for tax lodgements and payments. Banks also introduced a period of temporary loan payment deferrals. For selected policy responses, see the appendices in Black S, K Lane and L Nunn (2021), ‘Small Business Finance and COVID-19 Outbreaks’, RBA Bulletin, September; Lewis M and Q Liu (2020), ‘The COVID-19 Outbreak and Access to Small Business Finance’, RBA Bulletin, September. 6
See RBA (2020), ‘Box B: Business Failure Risk in the COVID-19 Pandemic’, Financial Stability Review, October; Black, Lane and Nunn, n 6. 7
These included safe harbour provisions for directors from potential personal liability for insolvent trading, higher thresholds for owed amounts before creditors could issue statutory demands for payments, and extending the time allowed for companies seeking to appoint a restructuring practitioner. 8
Australian Government (2020), ‘Insolvency Reforms to Support Small Business’, Fact Sheet. This type of insolvency differs from other appointment types: the business must have less than $1 million of outstanding liabilities, must have no outstanding employee entitlements, and must have lodged all its tax returns. 9
The ATO also has visibility over unpaid superannuation entitlements owed to employees, which can inform tax enforcement decisions. 10
Relatedly, notifications to the ATO of late or incorrectly paid superannuation payments unpaid has increased substantially over the past few years. 11
Based on ATO annual reports. The value of collectable insolvency debt holdings of small businesses was $3.9 billion as at the end of 2018/19, and $8.7 billion at the end of 2023/24. 12
For more detail, see Bullo G, A Chinnery, S Roche, E Smith and P Wallis (2024), ‘Small Business Economic and Financial Conditions’, RBA Bulletin, October. 13
The range of profitability outcomes is much wider for small businesses than large businesses, see Bullo et al, n 13. A sizeable share of small businesses is not very profitable or makes a loss. The bottom 25 per cent of small businesses tend to make no (or negative) profits. Profitability, measured as profits (derived from total income and total expenses) divided by total assets, is as reported on business income tax returns. Total income includes some pandemic support measures, such as JobKeeper, where businesses have reported such measures for assessable income. 14
See Andrews D, E Bahar and J Hambur (2023), ‘The Effects of COVID-19 and JobKeeper on Productivity-Enhancing Reallocation in Australia’, CAMA Working Paper No 29/2023. 15
See RBA (2023), ‘Chapter 2: Resilience of Australian Households and Businesses’, Financial Stability Review, October. 16
For more detail, see Bullo et al, n 13. 17
This Focus Topic measures the employment of insolvent firms exactly one year prior to the insolvency event, rather than at the time of insolvency. This approach gives a more accurate picture of the size of insolvent firms, by taking into account the job shedding that typically occurs in the lead up to a firm entering insolvency. 18
We are unable to disaggregate the debts of insolvent companies by bank and other creditors. However, most bank lending to businesses is secured. 19
Secured creditors – most likely banks – have additional rights in small business restructuring (although these businesses are unlikely to hold much secured debt due to their size) and voluntary administrations. 20
Detailed data based on external administrator reports lodged with ASIC show that more than 80 per cent of these insolvencies have an estimated dividend payout of 0 cents in the dollar to unsecured creditors. See Series 3 data in ASIC (undated), ‘Insolvency Statistics’, available at <https://asic.gov.au/regulatory-resources/find-a-document/statistics/insolvency-statistics>. However, these data are only available for around 60 per cent of total insolvencies in 2023/24, and as such, may not fully represent the outcome for unsecured creditors for all insolvencies. Unsecured creditors of businesses that pursue a small business restructure likely benefit from re-negotiated terms as the business continues to trade. Research using the first cohort of small businesses to enter this process indicates that unsecured creditors – likely to be other businesses or non-banks – receive some payment through the insolvency process. For more detail, see ASIC (2023), ‘Review of Small Business Restructuring Process’, Report No 756, January. 21
However, there is clear growth in nominal earnings prior to the insolvency event. In the year following insolvency, average earnings for affected workers who gain employment are lower relative to their earnings trend at the insolvent firm. 22
Businesses that enter a small business restructuring agreement are slightly smaller on average than all other insolvency types, and on average retain most of their employees a year after entering insolvency. 23
There are also business loans from lenders that may be secured against home equity. Where these apply to small business owners who are operating their business as a partnership or as a sole trader, any failure to repay debts will show up as a business-related personal insolvency. 24
Small business performance varies more widely than larger businesses, with a sizeable cohort experiencing negative annual revenue growth each year. Furthermore, revenue growth is more variable year to year. This also limits small businesses’ access to credit, which can be used to smooth through temporary cash flow difficulties. For more detail, see Bullo et al, n 13. 25