Even when (not if) coronavirus pandemic has passed, Europe could find the most damaging economic legacy is not the vast piles of government debt but the hundreds of billion euros in liabilities that have landed on companies.

Businesses were forced to take loans to survive the lockdowns that cut off their cashflows this year. When that crisis support ends, their finances risk being stretched to breaking point, and small firms are already sounding the alarm.

Politicians are being asked to help viable companies clean up their balance sheets, or let them grapple with debt burdens that could cripple investment and job creation for years to come.

“With every week that goes by, the chances of survival for closed businesses are thinning,” said French business man running small enterprise. “We’ve never seen a crisis on this scale with systemic risks looming in the background.”

The risk extends beyond the companies themselves. Battered balance sheets could spark a cycle of defaults and bankruptcies that would hit the banking sector and deepen the downturn.

Euro-area companies added more than 400 billion euros ($475 billion) in debt over the first half of this year, compared with 289 billion euros in the whole of 2019, according to Eurostat data. The European Commission warned last week that “servicing debt could be challenging particularly in sectors impacted by the pandemic in a more lasting way.”

In Germany, which has so far come through the crisis better than most of its peers, the Bundesbank predicts that insolvencies will rise by more than 35% by the first quarter of next year. A survey by SME United, another lobby organization, showed around half of small and medium-sized businesses in France and Italy are worried about failing.

Some estimations say that Italian and French small businesses alone will need 100 billion euros in recapitalization, on top of liquidity aid.

Ultimately, the solution is probably to persuade European companies to reduce their reliance on bank loans, which they use to a much greater extent than U.S. businesses.

In the medium term though, proposed solutions require government support. That includes tools to prevent insolvency so working companies aren’t buried under their debt.

For the smallest businesses, that could mean direct fiscal grants to cope with fixed costs. For the bigger ones, subordinated loans or equity injections would be more appropriate.

Such ideas have seen opposition though. An EU “solvency support instrument” failed to get enough backing from governments at a summit in July even as they hammered out their blockbuster 750 billion-euro recovery fund.

Now the focus is on securing similar kinds of support through the European Investment Bank and other EU programs, along with national solutions.

In France, which has seen the biggest surge in corporate debt, from already high levels, the government is preparing a mechanism it hopes will channel around 20 billion euros in partial equity to small companies. It would involve banks distributing equity loans, mostly refinanced by special investment vehicles.

French banks and the state are still trying to work out how to keep costs low while ensuring returns are high enough to get funds involved. The program also needs to limit the risk borne by the government, and respect EU rules on state aid.

Spain has a 10 billion-euro fund to support larger, strategic firms with subordinated loans, equity and convertible bonds.

In Germany, the government is supporting businesses who were forced to shut down with direct cash payments. In fact, Italy and Germany stand out in their use of grants and other aid that doesn’t need to be paid back, according to the EU’s competition chief, Margrethe Vestager.

The European Commission recently loosened its rules on subsidies again so that governments can cover as much as 3 million euros of companies’ fixed costs. That could be one small step toward an extensive overhaul that reshapes corporate finance for the post-pandemic era./bloomberg

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