The Corporate Credit Paradox: How Zombie Companies and Cheap Credit are Stifling Innovation

Cheap debt is keeping zombie companies alive while innovative and profitable crypto companies struggle to raise loans from traditional institutions.

In this guest post for The Fintech Times, Sid Powell shares his observations about the growing appetite for DeFi solutions, and how DeFi is revolutionising accessibility to loans in APAC.

He also addresses solutions where DeFi is the key to unlocking such corporate credit and allowing profitable businesses to grow, and how firms are answering the growing needs for DeFi solutions in APAC.

Sid Powell is the CEO and Co-Founder of Maple Finance, an institutional capital market built on the public blockchain. Sid comes from a background in debt capital markets and institutional banking. During his career in traditional finance, he participated in $3 billion-plus of corporate bond issuance, established and ran a $200 million bond funding programme, and managed Treasury at a commercial lending fintech company.

Corporate Debt Makes the World Go Round

Corporate debt is a significant source of financing for businesses and access to it is essential for any company looking to expand sustainably. One advantage to obtaining corporate debt is that it helps maintain profits within an organisation and has a lower financing cost compared to equity. Yet, while much has been said about the potential inflationary pressures of central bank accommodative monetary policy, the stifling of innovation has been less discussed.

Zombie companies, those that earn enough money to repay their debts and continue operating, but not enough to increase growth, are surviving on unsustainable cheap debt from banks and credit institutions. The impact of Covid-19 has given further rise to this discussion, which is putting a huge amount of pressure on these companies. As a result, governments have issued large-scale support measures to counteract the strains.

Since the pandemic impacted the US economy in March, the Federal Reserve lowered its borrowing costs to near zero, further easing credit conditions by buying corporate bonds. With the Reserve easing credit conditions by supporting $750 billion in corporate bond issuance while backing a further $600 billion in lending to small and medium-sized companies, economists believe this cycle of easy money will allow more zombie companies to grow as weak growth forces central banks to further cut interest rates. According to data from Bloomberg, since the onset of the pandemic, over 200 companies have joined the status of zombie firms, racking up an impressive $2 trillion.

On the other hand, in the fast-maturing world of crypto, companies that are profitable, but have minimal amounts of debt are unable to access traditional sources of debt to expand their operations. Even though some financial centres, like Singapore, have made steps to formally welcome crypto native companies, many traditional institutions have yet to embrace lending to crypto firms, stunting innovation and the growth of an increasingly important sector. There are a few companies that are trying to fill this shortfall through decentralised finance (DeFi), but more needs to be done to unlock access to efficient corporate capital for crypto-based organisations.

Despite reservations from traditional financial (TradFi) institutions and asset managers, it is they who will be left behind as institutional adoption by crypto continues at a pace. Added to that is the fact that innovative financial centres like Singapore are accommodating innovation in this sector by providing more regulatory guidance. This further complements the emergence of powerful crypto funds and institutions in Singapore to manufacture an ecosystem.

The Irony of Accommodative Monetary Policy

Traditional sources of debt are extremely defensive. Zombie companies are able to access capital despite non-existent revenue or assets because of ultralow interest rates, weak banks, and weak insolvency regimes. Unfortunately, Covid-19 has done little to stem the rise of zombie companies. In an attempt to prevent a tidal wave of bankruptcies, the Federal Reserve purchased corporate bonds; however, in doing so, hundreds of ailing firms were given access to capital markets, creating more business borrowing to unproductive companies.

Profitable crypto companies with proven business models do not currently have access to credit or lending through traditional financial institutions. In order to access credit, these companies are very limited. Consequently, it’s stifling growth by forcing companies to access inefficient centralised debt with unfavourable conditions. Amber Group, a Hong Kong-based crypto trading startup, is one example. In June, the company raised $100 million in a Series B funding round from a list of high-profile and venture capital firms, including China Renaissance, Tiger Global Management, and DCM Ventures.

While many dedicated venture capital funds exist, typically profitable companies with proven business models would opt for debt rather than cash for equity financing. Venture capitalists require companies to give up shares and voting rights in exchange for capital, which is less attractive to profitable companies who should access credit to be paid off over time.

So, what’s the alternative?

Decentralised Finance is the Solution

DeFi and the transformative emerging technologies are the keys to unlocking such corporate credit and allowing profitable businesses to grow. The wider benefits are threefold:

● Borrowers: they have greater options for companies seeking more favourable loan terms, rates, and access to efficient debt that is not bound by geographic location;

● Economy: there is increased financial innovation;

● Investors: You and I through pension funds and opportunities have access to diverse investment opportunities.

As with the early days of Netflix when slow download speeds had people saying “that will never work”, there are improvements to be made. Behind this, however, is a significant technology breakthrough, which promises a Netflix moment for online finance. Already it has withstood the shocks of March 2020 and May 2021 and emerged stronger.

Appetite for DeFi solutions in APAC is growing, which is witnessed by Amber Group, quantitative crypto trading firm Alameda Research, and MGNR, a proprietary trading firm, to name a few, accessing DeFi loans in 2021.

It All Starts with Institutional Capital

Institutional capital is the lifeblood of corporate finance and drives the evolution of companies from startups to established companies or corporate entities. With increased access to institutional capital for profitable companies in crypto, there will be an increase in high-quality investment opportunities in Asia and globally.

Additional benefits of such access to capital include transparency and geographical and sector diversification for investors. With transparency, investors in DeFi can see where and to whom their funds have been loaned, see the terms of the loan, and see repayments. This, in turn, solves issues around insolvencies and bankruptcies. Another benefit is that DeFi is an effective base layer for institutional capital. Building fintech products on legacy banking systems are akin to running a modern grid on 19th-century copper wiring. In comparison, DeFi is a single layer, which is always on, easily accessed, and does not require costly infrastructure to use.

As the crypto space matures, traditional players are beginning to look to decentralised alternatives to create more efficient and transparent financial products.

DeFi still has a long way to go to giving crypto-based companies the boost they need when it comes to gaining access to corporate capital. Yet, strides are being made that are seeing traditional avenues sitting up to take notice. Not only that, but the wider benefits to the economy include transparency, capital efficiency, speed, and increased growth opportunities. On top of that, there are future opportunities for DeFi loans that go beyond crypto-based opportunities.

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