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Growing risk of debt trap

  • 28/09/2017
  • Jane Bray

A new warning has been issued about the growing risk of a “debt trap” if interest rates around the world stay near zero, which has encouraged borrowing by businesses, governments and consumers.

The Bank for International Settlements highlighted the vulnerability of business, government and consumer finances to interest rate increases in its quarterly report. Claudio Borio, the head of the monetary and economic department noted that since the financial crisis of 2007-08, global debt levels in relation to GDP had continued to go up, raising financial stability risks.

“Debt service ratios are only so low because interest rates have been falling so much,” Borio said. “There is a certain circularity in all this that points to the risk of a debt trap: the protracted decline in interest rates to unusually low levels, regardless of the strength of the underlying economy, creates the conditions that complicate their subsequent return to more normal levels.

Alongside this, the increase in the percentage of firms unable to cover their interest payments with their earnings – the so-called ‘zombie’ firms – does not bode well.”

Comments from a member of the Bank of England’s interest rate-setting committee fueled expectations that the cost of borrowing could rise as early as November. Gertjan Vlieghe, set out arguments for a rate rise from 0.25% “as early as in the coming months”. It would be the first increase in interest rates since July 2007.

Borio noted that corporate debt in the US, one of the countries at the heart of the financial crisis, “is now considerably higher than it was pre-crisis”, although overall private sector debt in relation to GDP had declined.

Due to the growing risk of the “debt trap” that companies are finding themselves in, it is more vital than ever that credit checks are carried out on companies you do business with. Whether they are a new or existing customer, a credit report from CoCredo will tell you everything you need to know on the company’s financial stability in an easy to read format.  It will tell you how much credit you should give them depending on their credit score and give you peace of mind that you made the right decision for you and your company.