Insolvency risk: understanding the Covid-19 domino effect

With global economic growth almost grinding to a standstill at the end of 2020, there is a global supply chains risk of widespread insolvency domino effect. This Covid-19-triggered event would affect virtually all sectors, geographies and business models.

Covid-sensitive sectors such as hospitality, non-food retail and transportation (especially air transport and automotive), are expected to withstand the worst of customer insolvencies. According to our experts, this could lead to global insolvencies increasing by +25% in 2021. What exactly is the domino effect and why is it such a threat in terms of corporate insolvency risk?

Triggering an insolvency chain reaction

In essence, the insolvency domino effect is a chain reaction which starts when an insolvent company is unable to meet its obligations to its trading partners. In its simplest form, this is when a company is unable to settle payments with customers and suppliers, leaving them with unpaid invoices.

Such insolvencies undermine wider supply chain liquidity making the domino effect more likely. This inability to meet obligations can trigger a knock-on effect through trading networks, along the linkages between companies, sectors and countries, ultimately leading to other payment defaults and insolvencies.

How vaccine economics delayed the insolvency domino effect

It is clear that the massive state assistance from governments has frozen the situation of many companies and led to an unprecedented and artificial fall in business insolvencies worldwide during 2020. The phasing out of state supports still depends on pandemic uncertainty. Yet, albeit gradually and orderly, it will trigger a return to a normalised number of insolvencies with two kinds of insolvencies: those of companies that were no longer viable before the crisis but were kept afloat by emergency measures, and those of companies weakened by the crisis, due to over-indebtedness or under-capitalisation.

Under normal conditions, a wide range of factors influence the severity, penetration and level of supply chain risk achieved by the insolvency domino effect.

  1. For example, while there is market liquidity and access to credit, the impact can be less pronounced.
  2. It also depends on the extent to which companies and sectors rely heavily on any given organisation before it goes bust. If reliance on a business is high – the famous sales or supply concentration factor – then the insolvency risk will be high too and the effect can be dramatic.
  3. Surprise is another key factor. If you are able to predict that a player will encounter difficulties you can mitigate or even prevent losses before they happen. On the other hand, if events take place at speed or on a very large scale with long supply chain or long payment terms across the chain, the corporate insolvency domino effect is potentially heightened.

Reducing supply chain risk during the calm before the storm

Thanks to unprecedented liquidity in the global markets, businesses now find themselves in a unique position. Indeed, C-suites have a golden opportunity to anticipate and reduce their supply chain risk prior to the withdrawal of state support, which still depends on pandemic uncertainty.

Achieving the required level of insight in-house may not be possible for many companies. But with solutions such as trade credit insurance in place, businesses can be confident they are protected against customer and supplier insolvency risk beyond their control.

Trade credit insurance compensates your company in the event of late or unpaid invoices, but more importantly, it helps you avoid bad debt in the first place. Trade credit insurers such as Euler Hermes invest significant time and resources in carefully mapping the global trade credit landscape, grading businesses’ risk levels and advising their clients on the safest way to do business.

It is often said that ‘know your customer’ is an essential business mantra, and this remains true in 2021. The more granular your insight into your customer’s ability to trade and pay, the better you can anticipate a potential domino effect.

28 results

Mar 26, 2021

Tourism: Europe at the recovery, but only in 2024

As governments race to contain new and more contagious variants of Covid-19, health passports will not be enough to revive tourism. According to Euler Hermes, the tourism industry could only see a recovery only in 2024. Read more.

Mar 22, 2021

Wholesale: a return to a sense of normal in 2021?

Learn more about the current challenges of the wholesale industry and how to protect your company against insolvencies.

Feb 19, 2021

Economic forecast 2021

The large-scale deployment of various Covid-19 vaccines will boost global economic growth. However, it will be necessary to wait until at least until 2022 for economic activity to return to pre-crisis level.

28 results