NEWS & INSIGHTS
Recent Increase in Company Insolvencies and Financial Stability
The Reserve Bank of Australia (RBA) has recently published its biannual Financial Stability Review (FSR), which includes comprehensive analyses on the current rise in company insolvencies and its implications for financial stability. We have summarised the key points from the FSR with our observations in this article.
Overview
The share of companies entering insolvency has risen sharply over the past couple of years, reaching levels observed in years following the global financial crisis. This increase is attributed to challenging economic conditions and a delayed catch-up effect from low insolvencies during the pandemic. Despite this rise, the RBA suggests that the related financial stability risks remain contained. We agree with the RBA’s view, but also note that current weak economic conditions coupled with volatility (driven by the Trump administration) could quickly accelerate market changes or impact financial stability and currency values.
Key Points
1. The RBA notes key causes of insolvencies include:
- Economic downturns and business-specific factors like poor management.
- Weak economic conditions exacerbate underlying business issues.
- Changes in policy and insolvency arrangements also affect trends.
The graph extracted from the FSR below outlines key causes for business failures observed from June 2005 to June 2024. While there are some variations in the figures, at a high level the reported drivers have remained the same over an extended period. The reporting of economic conditions as a cause of insolvencies coincides with broader macroeconomic conditions and has a higher variability.
The findings coincide with Wexted’s observations. Wexted has recently published articles Diversions: I see nothing, I know nothing!! The internal causes of business failure on the symptoms of business failure and;
Graph data based on external administrator reports, which represent a subset of total company insolvencies. Selected reasons; will not sum to 100 per cent as businesses can nominate multiple reasons. Earliest observation June 2005. Latest observation June 2024. Sources ASIC, RBA.
2. The RBA reports that Pandemic Support Measures:
- Reduced the risk of widespread financial stress and economic damage via income support policies and changes to the insolvency framework helped businesses stay afloat.
- Included Flexibility in tax payments and lodgements.
The ATO is a creditor of many insolvent companies. The temporary relief measures during the pandemic, e.g. payment and lodgement deferrals and interest-free payment plans, provided a substantial degree of relief to the businesses at the time, which also resulted in some companies accruing larger tax debts. The graph extracted from the FSR provides a good visual presentation of the level of tax liabilities at insolvency. The graph demonstrates that over time the tax liability has generally increased and that (unsurprisingly) in tougher economic conditions the percentage of companies with tax liabilities appears to climb.
With the ATO resuming its normal enforcement actions since September 2024, Wexted has observed an increasing number of ATO director penalty notices and general enforcement action, which has partially contributed to the growth in external administration appointments accordingly. Wexted’s recent article, Insolvency trends, updated ASIC guidance and the Small Business Restructuring Regime: What Directors Need to Know, elaborates on this trend.
* Data based on external administrator reports, which represent a subset of total company insolvencies. Earliest observation June 2007. Latest observation June 2024. ** From 2020, excludes reports where tax liabilities were unknown. Source: ASIC.
In addition, the insolvency framework changed in response to the COVID pandemic, including the introduction of Small Business Restructuring (SBR) in December 2020, which took effect in January 2021. Wexted has observed increasing uptake of SBR and provided a comprehensive FAQ on SBR, Small Business Restructuring – all you need to know.
For more details on insolvency law reform, refer to Wexted’s Spotlight on Reform, which encompasses the Government’s response to recommendations in the Report commissioned by the Parliamentary Joint Committee (PJC) on Corporations and Financial Services.
In general, Wexted is of the view that an open market with balanced and targeted government intervention in the form of specific programs, e.g. Fair Entitlement Guarantee (FEG) scheme, and decisive policy, e.g. SBR and Safe Harbour, will result in normalised outcomes. Check out Addressing Corporate Misuse of the FEG Scheme – Perspectives for more discussion on possible reforms to strengthen the integrity of the FEG scheme.
3. Current Economic Conditions. The RBA suggests that:
- Rising costs, weak demand growth, and higher interest rates have contributed to the increase in insolvencies.
- Insolvencies are highest in construction and hospitality due to industry-specific factors and economic conditions.
Everyone has noticed the increased cost of living. Insolvencies have also risen sharply in industries exposed to discretionary spending, notably hospitality. The market has also experienced a sharp increase in construction insolvencies since 2022 resulted from material shortages, higher labour and material costs. Wexted’s The Turnaround Podcast: New Leaders on Corporate Insolvency discussed the corporate insolvency surge in more detail.
4. Characteristics of Insolvent Companies. The RBA suggests:
- Most insolvent companies are small with insignificant debts.
- Many have a chance of recovery.
- Indirect effects on financial stability via job losses have been limited.
The two graphs extracted from the FSR below provide a visual overview of the size of insolvency companies and their debt levels.
As the graphs demonstrate, the majority of insolvencies involve companies with less than 20 employees and unsecured debt of less than $250,000. It is not necessarily clear to us on the data that such businesses generally have a chance of recovery, although from a formal insolvency perspective the continued rise of small business restructures provide some support for this view.
* Number of jobs 52 weeks prior to insolvency. Earliest observation March 2021. Latest observation June 2024. Sources: ABS (BLADE); ASIC; RBA.
Wexted has observed generally that small businesses are more vulnerable to financial difficulties. Check out The Turnaround Podcast: Spotlight on Safe Harbour with Michael Catchpoole, in which Andrew McCabe, Partner of Wexted Advisors, spoke about size and scale and the role of Safe Harbour in addressing at least a part of the decreasing number of significant entities entering insolvency.
*Data based on external administrator reports, which represent a subset of total company insolvencies. Series break in 2020 due to changes in ASIC's reporting methodology. Earliest observation June 2007. Latest observation June 2024. Source ASIC
5. Financial System Risks. The RBA reports that:
- Most insolvent companies are small and carry insignificant debts. The graphs in section 4 support this view.
- Banks have limited exposure to these businesses. The secured debt exposure of small business insolvencies as outlined in section 4, support this view.
- Job losses at insolvent companies have been limited, with most affected employees quickly securing new employment.
In light of the above, while the increase in insolvencies poses some risks, the overall impact on financial stability remains contained. Smaller companies are more vulnerable, but the financial system is expected to remain resilient even if insolvencies stay elevated.
Businesses facing financial difficulties should consider the various restructuring and insolvency services available to navigate these challenging times.
Contact one of our trusted experts at Wexted if you wish to explore options available to your business.
Published 7th May 2025
By Jessie Wang
Director