## Annex I. Policy Responses to the Pandemic Shock in Asia and the Pacific (wpiea2021016-print-pdf)

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### Introduction and immediate objectives
- COVID-19 triggered an economic contraction of unprecedented depth and synchronization across Asia and the Pacific, with most major economies experiencing infection peaks between March and April of 2020 (China: first cases in late-2019, peak in February 2020).
- Policymakers adopted a “whatever it takes” approach deploying monetary, fiscal, and financial sector policies rapidly and at scale to prevent large-scale job losses and firm collapses.
- Immediate corporate-sector objective: help firms survive a severe liquidity squeeze and prevent insolvency cascades while preserving the capacity for post-pandemic structural adjustment.
- Pandemic consequences highlighted:
  - Depletion of working capital and increased corporate debt, raising insolvency risks and constraining production recovery.
  - Acceleration of structural changes (shift to online commerce, digital payments, supply-chain reconfiguration) requiring firms to repair balance sheets and adjust business models.

### Immediate policy priorities as economies stabilize and recover
- Core priorities:
  - Avoid a crippling wave of drawn-out insolvencies and defaults.
  - Facilitate efficient restructuring of viable firms while allowing nonviable firms to exit.
  - Pivot support from broad-based liquidity measures to solvency-restoring policies and mobilize funding for new investment and retooling.
- Policy design should reflect country-specific conditions:
  - fiscal and monetary support already extended,
  - effectiveness and capacity of insolvency frameworks,
  - state of financial development,
  - available macroeconomic policy space.
- Transition guidance:
  - Continue emergency liquidity, guarantees, and transfers until robust recovery signs, but complement and gradually replace them with restructuring-focused measures.

### Three priority areas for the recovery phase
- Reinforce private debt resolution frameworks to “flatten the insolvency curve”:
  - Use greater reliance on out-of-court and hybrid restructuring to reduce court caseloads.
  - Strengthen formal in-court insolvency processes and implement simplified SME procedures.
- Ensure adequate financing to support corporate restructuring:
  - Leverage banks (bulk corporate credit providers) via regulatory flexibility and supervisory guidance.
  - Consider easing macroprudential settings in some cases, maintain capital well above prudential minimums, and temporarily curb capital distributions.
  - Use publicly funded equity injection vehicles as backstops if private capital is insufficient and promote non-bank financing channels and special investment vehicles.
- Facilitate access to risk capital for firms and startups to speed reallocation:
  - Eliminate tax bias against equity, incentivize debt-to-equity conversions, simplify startup regulations, and foster equity-like instruments for SMEs (non-voting preferred shares, convertible subordinated bonds, profit participation loans).
  - Public sector can act as “venture capitalist of last resort” with safeguards to catalyze private risk-taking.

### Key features and operational guidance for debt resolution
- Interim measures used during the crisis (moratoria, suspension of wrongful trading liability, forbearance) are temporary and not sustainable as they interfere with creditor rights and delay restructuring.
- Recovery-phase preparation:
  - Scale back interim measures to surface solvency problems.
  - Use applications for financial support to identify distressed firms.
  - Allocate resources to expand court and institutional capacity over the medium term.
- Triage and restructuring modalities:
  - Triage firms into: (i) viable with straightforward financing problems → out-of-court or hybrid restructuring; (ii) firms with major viability issues → formal court-based processes; (iii) strategically important insolvent firms → fiscal solvency support.
  - Out-of-court mechanism features: market-driven creditor committees, master restructuring agreements, restructuring experts, mediation/arbitration, stand-by agreements, and pre-pack fast-track judicial confirmation where needed.
  - Simplified SME regimes and standardized restructuring templates can address high volumes of small cases cost-effectively.

### Effective insolvency system features (complex cases)
- Core system elements to strengthen:
  - Debtor-in-possession (DIP) reorganization to incentivize early restructuring (noting exceptions and implementation gaps).
  - Priority for post-petition finance to enable fresh funding in insolvency.
  - Hybrid procedures (pre-packs, preventive procedures) to multiply effective judicial capacity (intensive use of pre-packs can be equivalent to a five-fold increase in judicial capacity).
  - Simplified regimes for micro- and small enterprises.
  - Specialization of judges and insolvency professionals; use of technology and data (electronic case management, virtual hearings, insolvency data collection).
- Countries with minimal insolvency practice: prioritize solvency support for strategic firms and set up special restructuring mechanisms rather than attempting a full legal overhaul during the crisis window; pursue longer-term legal and institutional reforms.

### Financing and bank-sector considerations
- Aggregate corporate leverage and distress metrics:
  - Corporate debt-to-GDP reached 119 percent of GDP in 2020Q1, an increase of 35 percentage points relative to 2007.
  - In 2019, about 36 percent of the region’s total debt was held by firms with an interest coverage ratio (ICR) below two (country range: 10 percent in Japan to 50 percent in Indonesia).
  - Share of corporate debt at risk rose to 54 percent in early 2020.
  - Model simulations (21 countries) indicate firms in financial distress and at risk of insolvency account for 9 to 13 percent of total SME (in sample) employment, representing almost a doubling of SME jobs at risk due to liquidity and a 50 percent increase due to insolvency risks versus a no-COVID-19 scenario.
- Bank-sector strength and policy levers:
  - Tier 1 Capital Ratios (GFC (2008) vs COVID-19 (2019)): Japan: 9.1, 15.1; Australia: 7.1, 13.1; Korea: 8.8, 12.9; Singapore: 11.5, 15.3; Hong Kong SAR: 11.2, 18.5; China: 10.1, 11.8; India: 9.1, 14.7.
  - Liquid Assets to Short Term Liabilities (GFC (2008) vs COVID-19 (2019)): Japan: 43.31, 47.8; Australia: 27.5, 34.2; Korea: 102.5, 101.22; Singapore: 77.9, 73.8; Hong Kong SAR: 50.0, 176.1; China: 42.23, 55.3; India: 48.3, 22.9.
  - Authorities should use regulatory and supervisory flexibility to avoid procyclical credit contraction, clarify loan classification and provisioning rules, intensify on-site monitoring, and consider targeted macroprudential easing (examples: increasing loan-to-deposit ratios, lowering NSFR stable funding factors, excluding central bank reserves from leverage ratio, lowering liquidity coverage ratios).
  - Prudential buffers (counter-cyclical buffers, capital conservation buffer) are designed to be used in stress, but practical impediments exist; consider temporarily restricting capital distributions (dividends, buybacks, bonuses) as done or recommended in Australia, India, Korea, Singapore, Thailand, Vietnam.
  - Incentivize private capital raising (supervisory dialogue, matching public contributions, tax incentives such as notional return deductions) and deploy publicly funded recapitalization funds as backstops with safeguards against moral hazard and conflicts of interest.

### Public equity and equity-like support — design and safeguards
- Rationale for public equity support:
  - Equity strengthens balance sheets immediately, expands borrowing capacity, and allows public recoupment of upside; useful where private equity is insufficient amid high uncertainty.
- Design principles for public equity funds:
  - Clear mandate, strong governance, high transparency, upfront selection criteria for distressed but viable firms, caps on executive compensation, restrictions on dividends and buybacks, time-bound interventions, and explicit exit policies.
  - Seniority tradeoffs: weigh fiscal protection against crowding out private junior financing; consider pari passu protections to leverage private capital.
- Equity-like instruments for SMEs:
  - Incorporated SMEs: non-voting preferred shares, convertible bonds with conversion conditional on performance; public sector receives upside via dividends or tax arrangements without managerial control.
  - Unincorporated SMEs: subordinated loans or profit participation loans with payments linked to firm profits.
  - Governance safeguards: benchmarking, enhanced monitoring, reporting requirements, and penalties for misreporting.

### Structural change, reallocation, and labor policy implications
- Pandemic drives both cyclical and reallocation shocks; expected persistent changes include more shopping-from-home, less contact-intensive services, decentralized work arrangements, and supply-chain reconfiguration.
- Policy implications:
  - Allow nonviable firms to exit to avoid “zombies” that impede resource reallocation.
  - Shift employment policy from job protection to active labor market policies that facilitate job-switching and reallocation into growth sectors.
  - Facilitate access to risk capital to finance retooling and sectoral shifts.

### Practical coordination and implementation priorities
- Coordinate across agencies, stakeholders, and possibly set up special government entities (tripartite commissions, special restructuring vehicles) to manage large-scale insolvency responses.
- Continuously monitor outcomes and adjust policy measures as recovery unfolds and insolvency caseloads materialize.

*Source: wpiea2021016-print-pdf*

### Annex I. Policy Responses to the Pandemic Shock in Asia and the Pacific  _____________30

### Annex I. Policy Responses to the Pandemic Shock in Asia and the Pacific  _____________30

### Introduction
- The outbreak of the coronavirus disease (COVID-19) triggered an economic contraction of unprecedented depth and synchronization.
- In Asia and the Pacific, most major economies experienced infection peaks between March and April of 2020, although in some countries new cases continued rising through the summer.
- The decline in mobility, along with the collapse in external demand, caused a sharp downturn in regional activity that was broader and deeper than experienced in the Global Financial Crisis (GFC).
- Policymakers adopted a “whatever it takes” approach in their initial response to help firms survive the shock and prevent a more severe economic collapse.
- Governments and central banks across the region rapidly deployed monetary, fiscal, and financial sector policies on an unprecedented scale, which helped prevent negative feedback loops that could have exacerbated the economic downturn.
- Immediate objective in the corporate sector: help firms survive the severe liquidity squeeze triggered by a collapse in operating income and prevent large-scale job losses.
- The pandemic has contributed to a depletion of working capital and an increase in debt for many firms, raising insolvency risks and limiting their ability to restore production.
- The pandemic is expected to trigger important structural change, including shifts in consumer preferences and a reconfiguration of supply chains; firms will need to both repair balance sheets and adjust business models to operate successfully in the post-pandemic economy.
- 1 The authors would like to thank Romain Duval for helpful comments and suggestions. Paola Castillo provided able research assistance and Livia Tolentino editorial support.

### Immediate policy priorities as economies stabilize and recover
- Avoid a crippling wave of drawn-out insolvencies and defaults.
- Facilitate efficient restructuring of viable firms while allowing nonviable firms to exit.
- Pivot policy support for firms from broad-based liquidity support to measures that help restore the solvency of viable firms.
- Address excessive corporate leverage while mobilizing funding for new investment and retooling.
- The depth and broad-based nature of the pandemic shock, unusually large uncertainty about its duration and sectoral impact, and the large negative macroeconomic and social externalities that mass bankruptcies would generate justify active government support.
- The specific measures appropriate for each country will vary depending on:
  - the fiscal and monetary support extended when the pandemic hit,
  - the effectiveness and capacity of existing insolvency frameworks,
  - the state of financial development, and
  - the available macroeconomic policy space.
- Many corporate support measures introduced (emergency liquidity support, credit guarantees, direct fiscal transfers) should continue until there are clear signs of a robust recovery, but should be complemented and gradually replaced by policies geared toward facilitating and supporting corporate restructuring.

### Three priority areas for policy in the recovery phase
- Reinforcing private debt resolution frameworks to “flatten the insolvency curve” and facilitate large scale corporate restructuring.
  - The flow of insolvency cases has been contained so far by initial liquidity support and other interim measures, but this is not sustainable over a prolonged period.
  - Greater reliance on out-of-court and hybrid restructuring mechanisms would help address firms’ need for financial restructuring while effectively “flattening the insolvency curve” by reducing the number of court cases to a manageable level.
  - Formal in-court debt resolution frameworks should be strengthened to ensure a more efficient formal insolvency process for firms with major viability problems.
  - Simplified procedures for SMEs can help resolve a high number of small insolvency cases at a reduced cost.
- Ensuring adequate financing to support corporate restructuring in the post-pandemic recovery.
  - Banks provide the bulk of corporate credit in most financial systems in Asia and the Pacific.
  - Authorities should use the flexibility built into existing regulatory and supervisory frameworks to ensure banks maintain an adequate flow of credit to the economy.
  - In some cases, easing macroprudential settings will be appropriate.
  - Maintaining capital well above prudential minimum levels will support banks in providing new financing and taking on more risk in corporate restructurings.
  - Policymakers may need to temporarily curb capital distributions and strengthen incentives for banks to proactively raise private capital.
  - A publicly funded vehicle for equity injections can be a useful backstop for banks if private capital is not forthcoming.
  - Non-bank sources of financing for corporate restructuring, including special investment vehicles, should also be promoted.
- Facilitating access to risk capital for existing firms and startups to speed up the reallocation of resources into growth sectors.
  - Many firms in Asia and the Pacific are already highly leveraged and will need new equity to retool in a post-pandemic world.
  - Policymakers can help by eliminating the tax bias against equity, providing incentives for debt-to-equity conversions, simplifying regulations and reducing the cost of launching startups.
  - SMEs are a significant source of employment in the region and have been hit hard by the crisis, which may justify additional support.
  - Authorities can promote new financial instruments for SMEs such as equity-like finance that does not involve shareholder control (e.g., non-voting preferred shares, convertible subordinated bonds, or profit participation loans).
  - Where private equity may be insufficient owing to heightened uncertainty after the pandemic, the public sector can facilitate raising new equality, as a “venture capitalist of last resort” with appropriate safeguards to guard against moral hazard. This can catalyze private risk-taking and lay the foundations for a more robust equity culture in Asia.

### Organization of the paper
- Section II: provides a short summary of the impact of the COVID-19 outbreak on economies in Asia and the Pacific and how policymakers responded to help firms.
- Section III: discusses why and how the initial policy response will need to adjust in the next phase as economies recover and financial support is scaled back.
- Section IV: lays out the key policies to support resource reallocation in the corporate sectors in the recovery phase.

*IMF Working Paper — Annex I. Policy Responses to the Pandemic Shock in Asia and the Pacific*

### Section V offers brief concluding reflections.

### wpiea2021016-print-pdf - Section V offers brief concluding reflections.

### II. AN UNPRECEDENTED POLICY RESPONSE TO A CRISIS LIKE NO OTHER
- The outbreak of COVID-19 triggered an economic contraction of unprecedented depth and synchronization; economic activity and trade fell sharply in the first half of 2020.
- Key sector impacts: hospitality and tourism, manufacturing, and personal services were particularly hard hit.
- Timing and intensity across Asia and the Pacific varied:
  - China: first cases in late-2019, peak in new cases in February 2020.
  - Most major economies: first wave peak between March and April 2020.
  - Several countries contained initial waves but later experienced renewed local outbreaks; most Pacific island countries largely avoided local outbreaks.
- Governments implemented stringent lockdowns; intensity of containment measures peaked in March and April and eased from May onward, with re-tightening in locations with renewed outbreaks.
- Financial conditions tightened sharply in March 2020:
  - U.S. dollar and domestic currency funding sources seized up.
  - Benchmark stock market indices plummeted.
  - Consumer and business sentiment fell; services and manufacturing activity declined steeply.
- Growth forecasts were downgraded substantially: real GDP expected to contract in 2020 and only partially recover in 2021.
- Policy response (“whatever it takes”) combined fiscal, monetary, and financial measures:
  - Fiscal: on-budget measures (subsidies to firms to maintain employment; deferral of tax obligations) and off-budget quasi-fiscal measures (loan guarantees).
  - Monetary: traditional policy rate cuts plus unconventional instruments; quantitative instruments targeted liquidity to stressed corporate funding markets and firms with cash flow shortfalls.
  - Financial sector: stepped up lending by state-owned commercial/development banks; time-bound moratoria on debt service and restrictions on insolvency/debt enforcement; temporary easing of macroprudential liquidity and capital buffers; regulatory guidance including, in some cases, forbearance on bank loan classification.
- Policy combinations used for greater impact (examples):
  - Central banks provided funding to banks for on-lending to corporates, with government guarantees.
  - Korea created special purpose vehicles (SPVs) to purchase corporate securities and SME loans, with central bank funding and government equity for loss absorption.
- Policy instrument choice reflected financial system structure:
  - Bank-dominated systems with many SMEs focused on ensuring bank credit flow.
  - Market-based systems focused on stabilizing funding markets and market liquidity.
- Outcomes of rapid policy deployment:
  - Decisive monetary easing helped stabilize financial markets; equity markets rebounded and overall declines were shallower than in the GFC.
  - Pressures in domestic and dollar funding markets eased, aided by U.S. Federal Reserve swap lines to several countries.
  - Credit to the corporate sector rose in the first half of 2020 in most major economies in the region.
  - Bank lending standards eased in several countries in Q1 but tightened subsequently.
  - Signs of deteriorating loan quality were muted by policy support and moratoria, though upticks in special mention and non-performing loans observed in a few countries.

### III. MOVING FROM THE INITIAL LIQUIDITY SUPPORT TO SOLVENCY SUPPORT
- Rationale: initial liquidity support was critical to prevent collapse, but many firms are now financially weakened and face higher insolvency risks that could limit recovery and growth.
- Corporate vulnerability indicators:
  - In 2019, about 36 percent of the region’s total debt was held by firms with an interest coverage ratio (ICR) below two (country range: 10 percent in Japan to 50 percent in Indonesia).
  - Available data for the first half of 2020 indicate significant declines in revenues and earnings for many non-financial companies; unprecedented liquidity support increased corporate debt burdens.
  - Share of corporate debt at risk rose to 54 percent.
  - Corporate leverage increased and negative corporate rating actions occurred.
- Insolvency risk dynamics:
  - Liquidity support, moratoria, and regulatory forbearance mask underlying solvency problems; insolvencies could rise materially once such measures are phased out.
  - SMEs face greater financial stress than larger firms due to concentration in services and limited access to financing.
  - Model-based simulations using firm-level data for 21 countries show:
    - Firms in financial distress and at risk of insolvency account for 9 to 13 percent of total SME (in sample) employment, depending on the stress measure chosen—insolvency or illiquidity.
    - This represents almost a doubling of SME jobs at risk due to liquidity risks (and a 50 percent increase due to insolvency risks) vis-à-vis a scenario without COVID-19.
- Structural changes and reallocation:
  - Pandemic accelerates transitions (brick-and-mortar to online commerce; expansion of digital payments and finance) and may cause permanent shifts in consumer preferences and supply chain reconfiguration.
  - Concentration of negative corporate credit rating actions in sectors such as hospitality, transportation and logistics, and retail trade signals expected resource reallocation.
  - Rising dispersion of stock prices in the United States and many Asia and Pacific markets during the pandemic may indicate expected sectoral shifts.
- Policy shift needed:
  - Move from preserving operations and specific jobs to enabling restructuring and solvency restoration.
  - Allow nonviable firms to exit to avoid “zombies” that retain resources and deter entry.
  - Employment policy should transition from job protection to active labor market policies facilitating job switching.
  - Financial support should shift from emergency liquidity to financing that strengthens solvency and promotes restructuring.
- Corporate triage and institutional capacity:
  - Policymakers must identify viable firms and support restructuring while enabling non-viable firms to wind down.
  - Effectiveness depends on insolvency system capacity and legal frameworks:
    - Larger economies (Japan, Korea, Australia, China, India) have well-established frameworks; lower-income countries (Cambodia, Lao PDR, Myanmar, Mongolia) often have minimal insolvency practice.
    - Low formal insolvency numbers in some countries reflect limited professional/judicial capacity, social stigma, low trust, and unfamiliarity with insolvency systems—leading viable firms to simply close.
  - Legal frameworks vary: some countries have advanced systems; others need improvements particularly in informal/out-of-court restructuring, reorganization, liquidation, and debt enforcement regimes.
- Risks to insolvency systems:
  - Insolvency caseloads can surge far above normal during major crises, potentially overwhelming courts and causing prolonged reorganizations that erode franchise value and lead to unnecessary liquidations.
  - In countries with minimal insolvency practice, inability to restructure can lead to enforcement actions that cascade and close viable firms.
- Banks and corporate restructuring:
  - Banks have been insulated so far due to liquidity support, guarantees, moratoria, and forbearance.
  - As support is scaled back, firm solvency will become clearer, pressuring banks to restructure or write down loans.
  - Bank stocks underperformed broader equity markets since crisis onset; default probabilities rose sharply initially, though much of the increase has since reversed.
  - Significant loan write-downs remain a risk, especially in emerging and low-income economies, potentially constraining bank financing for firms.

### IV. KEY POLICIES FOR THE CORPORATE SECTOR IN THE RECOVERY PHASE
- Policy objective: continue emergency measures until clear recovery signs, but complement and eventually replace them with measures that facilitate corporate restructuring and recapitalization.
- Rationale for active public sector solvency support:
  - The deep, broad-based, and uncertain pandemic shock may deter private capital; liquidity support against high-quality collateral may be insufficient.
  - Public solvency support can prevent macroeconomic and social externalities from mass bankruptcies.
  - Public support may be warranted for SMEs as well as large/strategic firms due to aggregate social/economic costs of SME failures.
- Three complementary policy areas for recovery phase:
  - Reinforcing private debt resolution frameworks to flatten the insolvency curve and facilitate large-scale restructuring.
  - Ensuring financing is available to support restructuring of firms in the post-pandemic recovery.
  - Facilitating access to equity for existing firms and startups to speed reallocation into growth sectors.
A. Reinforcing Private Debt Resolution Frameworks to Flatten the Insolvency Curve
- Interim measures in immediate response:
  - Temporary reductions in new insolvency filings due to reduced court activity.
  - Suspensions of wrongful trading liability in some countries (e.g., Singapore, Australia, India) to avoid premature insolvencies.
  - Moratoria on debt enforcement in a few countries; India’s moratorium on insolvency cases was absolute, including voluntary debtor-initiated cases.
- Interim measures are not sustainable: they interfere with creditor rights and delay necessary restructuring and reallocation.
- Preparation steps for recovery phase:
  - Scale back interim measures so solvency problems can be addressed expeditiously.
  - Actions should reflect downturn severity, potential insolvency volumes, and institutional capacity.
  - Use applications for financial support by firms to gauge potential corporate distress once liquidity support and interim measures are removed.
  - Identify and address insolvency regime weaknesses; allocate resources to expand court and institutional capacity (noting substantial court capacity increases are medium-term achievements).
- Objective: “flatten” the insolvency curve so courts are not overwhelmed.
  - Use special mechanisms (out-of-court or hybrid restructuring) to allow debt restructuring with little or reduced court involvement.
  - Flattening reduces cases adjudicated by courts to levels commensurate with administrative capacity while addressing corporate distress expeditiously.
- Triage process:
  - Identify viable firms with relatively straightforward financing problems for informal out-of-court or hybrid restructuring; reserve court resources for firms with major viability problems requiring formal bankruptcy.
  - Authorities may separately identify insolvent firms meriting preservation for social or strategic reasons; these should be addressed via fiscal solvency support.
- Triage challenges:
  - Pandemic alters business models, complicating viability assessments.
  - Start triage with pre-pandemic financial condition (sustained profits as indicator of potential viability); incorporate sector- and firm-age-differentiated indicators, performance under health restrictions, and projections of restriction duration.
- Out-of-court restructuring:
  - Relatively straightforward restructuring cases for viable firms should be resolved via special out-of-court mechanisms.
  - Out-of-court mechanisms were widely used in the 1997/98 Asian financial crisis where insolvency systems were weak.
  - Benefits: cost-effective, market-friendly, speedy; suitable when court capacity is limited; aligns with regional preference for negotiated solutions over litigation.
- Features needed for effective out-of-court restructuring:
  - Market-driven approach with possible government support (financial, regulatory, tax incentives).
  - Use of general protocols or master restructuring agreements to foster creditor participation.
  - Use of restructuring experts; dispute resolution via mediation or arbitration.
  - Stand-by agreements to prevent actions that would alter creditor positions during restructuring.
  - Option for a fast-track insolvency case (“pre-pack”) to obtain prompt binding judicial confirmation where holdout creditors hinder agreements.

*Italic: Source: wpiea2021016-print-pdf - Section V offers brief concluding reflections.*

### Box 1. Key Features of Effective Out-of-Court Restructuring Mechanisms

### Box 1. Key Features of Effective Out-of-Court Restructuring Mechanisms

### Government involvement and creditor coordination
- Government involvement should be supportive and market-driven: banks form creditor committees and act as lead creditors; administrative support and endorsement by the government can be helpful (Laryea, 2010). Support from the banking supervisor is also important.1
- Government can incentivize participation by offering financing when market failures prevent private creditors from providing adequate financing (example: U.S. government support for auto companies during the GFC).
- Creditor participation must be active and comprehensive for informal restructurings to be effective; participation is voluntary in some systems (Japan) but can be enhanced by adherence to general protocols (INSOL Principles; “Bangkok framework” in Thailand) or master restructuring agreements.2
- “Carrots and sticks”: credible threat of bankruptcy, tax incentives, regulatory incentives for bank creditors, and monetary sanctions for undue negotiation delays can foster participation (Mako, 2001; Claessens, 2005).
- Restructuring experts assist by analyzing viability, drafting restructuring plans, and resolving disputes via mediation or arbitration with legal experts.3
- Dissenting creditors: master restructuring agreements can bind creditors to majority decisions; absent such agreement or requisite majorities, a fast-track insolvency case (“pre-pack”) should be available to obtain prompt judicial confirmation of plans (Korea, Japan).
- Stand-by agreements: participating creditors and debtors should commit to abstain from actions that alter creditors’ relative positions; judicial intervention may be necessary to obtain a stay of creditor actions where dissent exists.

### Efficient out-of-court restructuring for SMEs
- High volumes of distressed SMEs can overwhelm courts; special out-of-court restructuring regimes for SMEs (Japan, Korea, Malaysia, Thailand) are less complex and feature government advisory and financial support.7
- Capacity to provide SME support may need scaling if insolvency cases surge.
- Standardized solutions (restructuring plans adjusted to basic debtor characteristics) can accelerate restructuring of large numbers of SMEs; these lie between tailor-made solutions and across-the-board measures.8
- Standardized solutions are less precise but simpler and less costly than individualized viability analyses; example: Iceland during the GFC—SME debt written down to discounted cash flows or asset liquidation value.9

### Effective insolvency frameworks and key features for complex cases
- Temporary out-of-court mechanisms can facilitate restructuring of viable enterprises without overwhelming courts, but court-led insolvency procedures remain necessary for more extensive reorganizations.
- Countries should assess insolvency systems against international standards (World Bank Principles; UNCITRAL Legislative Guide) to identify gaps.10

Key features of effective insolvency systems:
- Debtor-in-possession (DIP) reorganization: debtors should be allowed to continue managing businesses while in reorganization to incentivize early use of the process. Most Asian systems incorporate DIP, with exceptions (India) and implementation gaps (China).
- Post-petition finance: priority for providers of fresh funds is necessary to enable financing for enterprises in insolvency; many Asian countries give priority (China, India, Japan, Korea), others do not (Indonesia) or lack specific rules (Vietnam). Specialized distressed asset funds increasingly provide this financing in large markets (China, India).
- Hybrid restructuring procedures: combine informal negotiations with minimal judicial intervention (stay of creditor actions, plan confirmation). Include pre-packaged and pre-arranged plans (in use in Japan, Korea, the Philippines, and to a lesser extent, in China) and preventive insolvency procedures (France, Italy, Spain, UK). Intensive use of pre-packs can be equivalent to a five-fold increase in judicial capacity.11 12
- Simplified regime for micro- and small enterprises: simplified insolvency procedures reflect that general procedures are often too complex and costly for SMEs (Japan, Singapore, Thailand, Korea have special procedures; Australia in process).
- Specialization of judges and insolvency professionals: dedicated insolvency courts exist in China, India, Korea, and Thailand; India has established regulation and qualification of insolvency professionals.
- Use of technology and data: electronic case management, electronic communications, virtual meetings/hearings, and insolvency data collection and analysis (Garrido et al., 2019).

Policy guidance:
- Emphasize reorganization of viable enterprises during the crisis window to avoid high economic costs from liquidation (Bernstein et al., 2019a and 2019b).
- Countries in the region should strengthen insolvency frameworks now; where informal restructuring mechanisms exist (Malaysia, Korea, Japan) these can be used to increase insolvency system capacity. Indonesia and Thailand should consider restoring and upgrading AFC-era frameworks; India and China can strengthen more recent informal mechanisms.

Selected national arrangements and tools (as described in source)
- Malaysia and Korea: preserved special restructuring mechanisms from the AFC.
- Japan: developed robust informal restructuring practices.
- Indonesia and Thailand: consider restoring/upgrading temporary AFC frameworks.
- India and China: strengthen informal restructuring mechanisms developed in recent periods.

### For countries with minimal insolvency practice
- Where insolvency practice is minimal, prioritize supporting solvency of strategic enterprises and set up special restructuring mechanisms for larger companies and SMEs rather than attempting full legal/institutional overhaul in the crisis timeframe.
- Longer-term strategy: revise insolvency laws and strengthen courts and insolvency profession.

### Ensuring adequate financing to support corporate restructuring and recovery
- Successful restructuring depends on availability of fresh financing; banks will play a critical role given their dominance in many Asia and Pacific financial systems.
- Authorities should use flexibility in regulatory and supervisory frameworks to avoid procyclical credit contraction (IMF and World Bank, 2020a).
- Supervisory guidance: clarify loan performance assessment, prudential treatment of restructured loans, and credit loss estimation; India provided guidance on asset classification and loan provisioning. Korea: banks bilaterally rescheduled principal and interest on loans amounting to about 4 percent of GDP (through August, 2020).
- Bilateral, commercially based loan rescheduling tends to be more targeted and less prone to moral hazard than blanket moratoria.
- Supervisors should intensify on-site monitoring of asset quality.

Macroprudential and liquidity adjustments
- Easing macroprudential policy settings may be appropriate to avoid undue tightening: examples in the region include increasing loan-to-deposit ratios (Korea); reducing required stable funding factor for short-term loans under NSFR (Singapore); excluding central bank reserves from leverage ratio (Japan); lowering the liquidity coverage ratio (Korea, Thailand).
- Ensuring banks have capital well above regulatory minimums is critical to support restructuring and new lending; past crises suggest a positive link between bank capitalization and credit growth.14

Capital adequacy and liquidity: selected metrics (GFC vs COVID-19)
- Tier 1 Capital Ratio (GFC (2008) vs COVID-19 (2019)):
  - Japan: 9.1, 15.1
  - Australia: 7.1, 13.1
  - Korea: 8.8, 12.9
  - Singapore: 11.5, 15.3
  - Hong Kong SAR: 11.2, 18.5
  - China: 10.1, 11.8
  - India: 9.1, 14.7
- Liquid Assets to Short Term Liabilities (GFC (2008) vs COVID-19 (2019)):
  - Japan: 43.31, 47.8
  - Australia: 27.5, 34.2
  - Korea: 102.5, 101.22
  - Singapore: 77.9, 73.8
  - Hong Kong SAR: 50.0, 176.1
  - China: 42.23, 55.3
  - India: 48.3, 22.9
- Notes: 1/ as of 2009 Q3; 2/ as of 2017 Q4; 3/ as of end-2010. Sources: Financial Soundness Indicators and Haver Analytics.

Forward-looking diagnostics and capital buffers
- Supervisors should update systemwide stress tests to reflect COVID-19 characteristics, differentiated sectoral impacts, and “low for even longer” interest rate prospects (Carletti et. al., 2020).
- Prudential capital buffers under Basel III are designed to be used in stress; counter-cyclical buffers are most suited for release but only Hong Kong SAR had a non-zero buffer at pandemic onset.16
- The capital conservation buffer (CCB) is not formally releasable but can be used temporarily; banks may be reluctant to use buffers if they must restore higher steady-state capital ratios (Blank et. al., 2020).
- Consider temporarily restricting capital distributions (dividends, buybacks, bonuses) to preserve capitalization; Basel standards already limit such distributions when buffers drawn down. Several economies recommended or directed dividend limits/deferrals: Australia, India, Korea, Singapore, Thailand, Vietnam.

Incentives and public backstops for bank capital
- Authorities can incentivize banks to raise private capital via supervisory dialogue, convening power, or financial incentives (matching public capital contributions at low cost); tax incentives (e.g., allowing deduction of a notional return on equity) can decrease cost of equity financing.19 20
- Publicly funded recapitalization funds can be a backstop when private capital is unavailable and financial stability is at risk; examples during GFC: Korea’s two public vehicles and the U.S. Capital Purchase Program (CPP) under TARP. Public injections should include safeguards for moral hazard, conflict of interest, and taxpayer protection (Dobler et. al., 2020).21

Role of non-bank institutions and special investment vehicles
- Non-bank financial institutions and investment vehicles can support corporate restructuring by promoting markets for impaired assets and acquiring distressed firms for turnaround (buyout funds); a conducive regulatory environment and operational flexibility encourage emergence of such players.22

*Source: Box 1. Key Features of Effective Out-of-Court Restructuring Mechanisms (wpiea2021016-print-pdf).*

### Box 2. Korea’s Bank Recapitalization and Financial Stabilization Funds

### Box 2. Korea’s Bank Recapitalization and Financial Stabilization Funds

### Overview
- During the GFC, Korean authorities preemptively established two largely publicly funded vehicles to capitalize banks and other financial institutions, subject to commitments to maintain corporate lending.
- Funds were designed to avoid the disincentives associated with common-share acquisition and to condition support on real-economy lending commitments.

### Bank Recapitalization Fund (Dec 2008)
- Purpose: conditional recapitalization program to help banks absorb potential loan losses from the GFC downturn.
- Maximum size and financing:
  - Maximum size: 20 trillion won (1.7% of GDP).
  - Financed by: loans from the Bank of Korea (10 trillion won), the Korea Development Bank (KDB) (2 trillion won), and the sale of secondary asset-backed securities to private financial institutions (8 trillion won).
- Instrument design:
  - Did not acquire common shares to avoid stock dilution.
  - Banks could raise capital by selling preferred stocks, hybrid bonds, and subordinated bonds to the fund within a pre-set ceiling based on asset size.
- Conditionality:
  - Access required commitments in an MOU to support the real economy through (i) extension of credit lines to SMEs and (ii) participation in debt-to-equity swaps of firms under workout programs.
- Implementation outcome:
  - In March 2009, first and only purchase: total of 4 trillion won of hybrid and subordinated bonds issued by 8 banks.
  - No further purchases executed due to Korea’s fast recovery from the GFC.
  - The Bank of Korea and KDB recovered their loans in 2014.

### Financial Stabilization Fund (May 2009)
- Institutional approval: Korea’s parliament approved institutional settings for a temporary “Financial Stabilization Fund” (FSF) in May 2009.
- Purpose and scope:
  - Conceived as a comprehensive and flexible “last resort” tool to safeguard financial sector soundness.
  - Eligible beneficiaries: all banks, non-bank financial institutions, and financial holding companies.
- Funding and powers:
  - Managed by the KDB.
  - Empowered to directly issue government-guaranteed bonds up to a ceiling approved by the National Assembly for its funding.
  - Flexibility to deploy equity purchases, loans, and loan guarantees.
- Conditionality:
  - Support was to be conditional on beneficiaries’ commitments to support lending to the real sector.
- Implementation outcome:
  - FSF did not enter into operation owing to the fast recovery of the Korean economy.
  - The legal authority under which the FSF was set up led to expire at the end of 2014.

### Pivoting to Equity Support for Non-Financial Firms — Rationale and Design
- Rationale:
  - Public equity support can complement liquidity assistance when private investors are unable or unwilling to provide sufficient financing, helping avoid large-scale bankruptcies.
  - Equity (or equity-like) support immediately strengthens balance sheets and expands firms’ capacity to borrow and invest until private capital returns.
  - Equity interventions allow governments to “capture some of the upside” from interventions.
- Targeting:
  - Should focus on firms and industries most affected by the pandemic and those delivering positive externality benefits.
  - Example: Korea’s “Key Industry Stabilization Fund” (May) managed by KDB and co-funded by private investors to provide conditional equity support to strategic sectors such as airlines and the shipping industry.
- Design considerations for public equity funds:
  - Strong governance: clear mandate, high transparency, clear exit policy.
  - Upfront selection criteria for distressed but viable firms; specify broader economic and social goals; transparent valuation criteria.
  - Conditions: caps on executive compensation; restrictions on dividends and share buybacks.
  - Interventions should be time-bound and have a clear commercial mandate to maximize recovery value and avoid warehousing bad assets.
  - Seniority tradeoffs: weigh limiting fiscal risks through greater protection against discouraging junior private financing later; accepting pari passu protection can leverage private financing while preserving upside gains.
  - Exit tools: past interventions allowed owners to repurchase shares at a premium, e.g., via equity warrants.

### Operational and Mindset Implications for Governments
- Government role shift:
  - From creditor seeking principal recovery to portfolio equity investor acting as a “venture capitalist of last resort.”
  - Authorities must accept additional risk and potential losses in exchange for longer-term or broader social gains.
- Performance assessment:
  - Evaluate public funds based on overall ex-post rate of return of the portfolio rather than individual investments to incentivize long-term capital gains and protect public agencies from political criticism on individual losses.

### Equity-like Support for SMEs
- Instruments for incorporated SMEs:
  - Non-voting preferred shares or convertible bonds with long repayment periods; conversion conditional on firm performance.
  - Public sector receives upside via dividend payments or temporarily higher future corporate tax payments in return for not assuming managerial control.
- Instruments for unincorporated SMEs:
  - Hybrid financing through subordinated loans or profit participation loans (interest payments depend on firm profits).
- Governance safeguards:
  - Industry-level benchmarking of key financial ratios, closer monitoring and reporting requirements, penalties for misreporting and fraud.
- Examples and precedents:
  - Germany and other European countries’ experience with such instruments; Italy’s early warning guidance used for benchmarking.

### Mobilizing Private Equity in Recovery Phase
- Need:
  - Firms will need more private equity to reduce debt overhangs, absorb idle labor, reallocate resources, and adopt new technologies.
  - The public sector will need private equity to eventually take over its holdings in supported firms.
- Structural constraint in Asia and the Pacific:
  - Large domestic savings are often invested in low-yielding bank deposits, government securities, or real estate.
  - Equity markets are generally smaller than U.S. and Europe; financial systems remain bank-centered with limited markets for longer-term and riskier capital.
- Immediate policy measures to encourage equity issuance:
  - Eliminate the tax bias against equity:
    - Tax systems allow interest deduction on debt but not dividend payments on equity.
    - Preferred solution: remove interest deduction.
    - Alternative: temporary subsidy to equity issuance at fiscal cost.
    - Example: Belgium, Italy and Turkey introduced an allowance for corporate equity (ACE) that adds a deduction for the normal return on equity, alongside the deduction for interest (IMF, 2016).
  - Provide incentives for debt-to-equity conversions and disposal of equity holdings:
    - Address barriers such as restrictions on owning nonfinancial companies, time limits for disposing converted equity, and higher capital charges for holding equity.
    - Supervisors could reduce holding limits or temporarily lower the capital charge on debt-equity conversions; tax authorities could eliminate tax on debt-equity swaps.
    - Ensure proper valuation and return to normal capital charges to incentivize timely disposal and avoid moral hazard.
    - Example: FSA in Japan considering relaxing the 5 percent limit on equity ownership in nonbank companies to encourage regional banks’ engagement.
  - Simplify regulations and reduce costs for startups:
    - Reduce procedures, time and minimum paid-in capital requirements for starting a business.
    - Provide tax incentives for job hires by startups.
    - Improve corporate governance to boost investor confidence.

### Key complementary policy priorities in recovery
- Reinforce private debt resolution frameworks to “flatten the insolvency curve” and prevent excessive insolvencies.
- Ensure adequate financing for corporate restructuring.
- Facilitate access to risk capital for existing and new firms.
- Coordinate across agencies and stakeholders; consider special government entities to coordinate large-scale insolvency responses and political entities (tripartite commissions) to build consensus on reforms.
- Continuous monitoring and adjustment of policy measures based on observed outcomes.

*Source: wpiea2021016-print-pdf - Box 2. Korea’s Bank Recapitalization and Financial Stabilization Funds*

### ANNEX II. THE FINANCIAL HEALTH OF NON-FINANCIAL CORPORATIONS AT THE ONSET OF

### ANNEX II. THE FINANCIAL HEALTH OF NON-FINANCIAL CORPORATIONS AT THE ONSET OF THE COVID-19 CRISIS

### Profitability of Nonfinancial Companies
- Operating profits declined steadily in the major Asian economies in recent years and fell sharply in the first half of 2020 owing to the pandemic.
- The share of firms with negative profits, measured by earnings before interest and taxes (EBIT), increased in 2019 across the region (except for the Philippines) and rose further in 2020 H1.
- In most economies, the share of firms with negative profits now accounts for nearly 30 percent or more of all firms.
- Firms with negative profits tend to be smaller on average based on their asset size; exception: Australia—share of firms with negative profit accounts for 66 percent of total in 2019, while their assets amount to only 3½ percent of total.
- Sample and data scope:
  - Sample includes listed and non-listed companies with market capitalization of more than US$1 million from S&P Global Market Intelligence.
  - Sample size (QIV 2019) in brackets: Australia (1653), Hong Kong SAR (1555), Japan (3861), Korea (2236), Singapore (574), China (4865), Indonesia (649), India (2855), Malaysia (954), Philippines (243), Thailand (769), and Vietnam (658).
  - India is based on fiscal year (April through March); calendar year used for other countries and jurisdictions.
  - Chart timing: most recent data include 2019 for Australia, Hong Kong SAR, Singapore; 2020Q1 for Korea, China, India, Malaysia, Philippines, Thailand; and 2020Q2 for Japan, Indonesia, and Vietnam.

### Leverage and Corporate Debt
- Corporate debt-to-GDP ratio reached 119 percent of GDP in the first quarter of 2020.
- This represents an increase of 35 percentage points relative to 2007.
- Much of the increase was driven by credit from banks and, in some instances, nonbanks (notably in China).
- Further deepening of capital markets facilitated the issuance of local currency-denominated corporate bonds.
- Leverage ratios (debt-to-assets) increased markedly since the GFC, notably in India, the Philippines, and Thailand, where they rose to around 35 percent or higher.
- The share of short-term debt declined since 2007, especially among firms with higher leverage, reducing corporate vulnerability to liquidity shocks.
- Data and scope notes:
  - Firms with market capitalization of at least US$1 million are included.
  - Weighted averages are based on total assets.
  - Most recent data timing: 2020Q1 for Korea, China, India, Malaysia, Philippines, Thailand; 2020Q2 for Japan, Indonesia, Vietnam; 2019 for Australia, Hong Kong SAR, Singapore.
  - In Australia, recent leverage data may be biased upward due to a change in accounting standards (AASB16).

### Debt-at-Risk and Interest Coverage
- Falling profitability and rising debt burdens have increased the risk of financial distress among NFCs.
- Interest coverage ratio (ICR) = earnings before interest and taxes divided by interest expenses; firms with an ICR of less than two are generally regarded as facing heightened risk to debt distress.
- The share of debt issued by firms with ICRs of less than 2 is higher now than during the GFC across the region.
- The share of debt held by firms with an ICR below 2 has increased further since the outbreak of the pandemic.
- Sample note: NFCs with capitalization of US$1 million or more are included. The most recent data uses 2020Q2 for Japan, Indonesia, and Vietnam, and 2020Q1 for other countries.
- Data caveat: metrics in Singapore are driven by a couple of large firms.

### Impact on Small and Medium Enterprises (ANNEX III)
- SMEs in the region account for 30-60 percent of the level of GDP and 30-90 percent of employment in their respective economies.
- SMEs are concentrated in services, making them particularly vulnerable in this pandemic. Female ownership of SMEs has risen over the past decade, highlighting SMEs’ role in inclusive growth.
- Survey and evidence-based impacts:
  - “The Future of Business Survey” (late May, 50 countries) found that a quarter of surveyed SME owners had closed their businesses between January and May 2020; hospitality saw around 50 percent shut down. Nearly three-quarters of businesses that had closed expected to reopen once containment measures were lifted. Among SMEs that remained in operation, about one-third reported a reduction in their workforce. The pandemic lockdown disproportionately impacted female business owners due to increased home care commitments.
  - Data from Korea’s Ministry of SMEs and Startups: at the peak of containment in early April, sales of small firms and merchants dropped by as much as 70 percent over a year ago; by July sales were still down 30 percent. A survey by the Korean Federation of Micro Enterprises in April found almost half of respondents would consider closing if the COVID outbreak persisted for more than six months.
  - Japan: the quarterly Tankan survey showed business conditions severely deteriorated in the June quarter of 2020 compared to March, with deterioration more pronounced among SMEs, particularly in non-manufacturing.
  - Thailand: surveys showed a sharp drop in the willingness of households to invest in SMEs.
- Note: the wide range of SME GDP and employment estimates partly reflects differences in the definition of SMEs across countries.

### Structural Change and Reallocation (ANNEX IV)
- Structural change involves reallocation of labor, capital, land, and technology within and across sectors; triggered by shocks to relative returns.
- Two shock types:
  - Aggregate shocks: transitory, limited long-run effects.
  - Reallocation shocks: permanent changes in relative returns, leading to permanent resource shifts; associated with changes in tastes and technology.
- The COVID-19 shock includes substantial cyclical components that may reverse when containment measures are lifted, but also accelerates technological disruptions and structural transitions (e.g., switch from brick-and-mortar to online retail; increased use of digital payments and finance).
- Expected persistent changes:
  - Consumer-side: more shopping from home and less consumption of contact-intensive services.
  - Corporate-side: more decentralized workforce use (including more work from home); reconfigured supply chains to reduce disruption risk.
- Implications for firms:
  - Some sectors will require firms to shrink, restructure, or exit.
  - Other sectors will gain new growth opportunities.
- Indicators suggesting substantial reallocation:
  - Forward-looking reallocation measure for jobs in the United States (Barrero et al. 2020) shows a substantial increase after February 2020.
  - Reallocation shocks expected to increase dispersion of equity returns; sharp increases in equity return dispersion observed in the United States and across many markets in Asia and the Pacific.
  - Marked concentration of negative corporate credit rating actions in some sectors indicates significant resource reallocation is likely.
- Data notes: Charts cited use Bloomberg, S&P Global Market Intelligence, and IMF staff calculations; Chart A.6 covers corporate ratings downgrades for January-July, 2020.

*Source: wpiea2021016-print-pdf - ANNEX II. THE FINANCIAL HEALTH OF NON-FINANCIAL CORPORATIONS AT THE ONSET OF THE COVID-19 CRISIS*

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_Source: https://www.imf.org/-/media/files/publications/wp/2021/english/wpiea2021016-print-pdf.pdf_