Is Australia heading for an insolvency crisis?

Interest rate rises are pushing more and more companies in Australia to collapse, data shows, and experts warn of more insolvencies to come as the tax office comes knocking for the first time in years.

The rates of businesses entering administration in Australia fell extremely low during the pandemic, as the below chart shows. The government’s much-publicised cash handouts to businesses to retain staff (JobKeeper) and the much less publicised cash handouts to businesses for no reason at all (cashflow boost) kept many otherwise dying companies ticking along.

In 2022 and 2023 that began to unwind. Rising interest rates sent businesses to the wall. And after a little break for summer, it’s not over.

Insolvency experts expect a further surge of customers in the industries most prone to cyclical swings — construction, manufacturing and logistics. This comes after a wild ride in markets and the high-profile collapse of US lender Silicon Valley Bank.

“In many ways, what we’ve seen over the past six months is the tip of the iceberg,” said Scott Taylor, partner at insolvency law firm Taylor David.

“When you start seeing global banks getting anxious, being sold off or collapsing, it’s a clear indication of wider uncertainty, with more to come,” Taylor said.

Insolvencies are a big deal. Most are small businesses, and in many cases small business loans are secured by the family home. When businesses collapse, the strain on people, families and children is real. Not to mention the employees put out of work.

This process of business collapse is, however, part of the Reserve Bank’s big plan. When companies fail, they release all the inputs they were using — employees, real estate, machines, vehicles, etc. Those items are now available for another business, reducing input costs and, in theory, reducing little by little the pressures that create inflation.

So don’t expect the RBA to cut rates just because insolvencies rise.

“2023 is likely to be the toughest year in recent times for Australian businesses,” said Jarvis Archer, head of business restructuring and insolvency at Revive Financial.

“While the ATO’s efforts last year brought in $6-7 billion of payments or debts under arrangement, that’s only a third of the additional pandemic debt, leaving many businesses yet to deal with their tax debts.”

With just three months to go until the next tax time, many businesses will be wondering how to meet their obligations to the ATO.

“The Australian Tax Office quite rightly showed some leniency during the COVID-19 period. However, there are many businesses that have not paid tax for the past two years,” said Taylor.

“With the ATO now back in enforcement mode, it’s inevitable that many of these businesses will be turning off the lights for good. In a practical sense, there are consequences for business owners who have swept their financial turmoil under the rug.”

As businesses go broke, people can declare themselves bankrupt — this is called personal insolvency. The generous COVID-era handouts that stuffed the Australian economy with cash meant personal insolvencies have been at record lows: under 10,000 last year, compared to 25,000 personal insolvencies a year pre-COVID. But that cash is being eaten away, and so personal insolvency rates are expected to return to pre-COVID levels.

“Challenges like rising interest rates and high inflation are putting many people under significant financial stress,” said Australian Financial Security Authority chief executive Tim Beresford.

When people enter personal insolvency, the biggest entities they owe money to are usually the big four banks. The good news is Australia’s banks are not likely to be driven broke by a few customers declaring insolvency.

They are not going to follow the path of Silicon Valley Bank — overall arrears rates are low, and the bulk of their lending is for housing, not business. The real estate market is a much bigger issue for banks, and that’s something you can expect the RBA to be keeping a close eye on.