More than four years since the covid pandemic first begun, the term “Insolvency Armageddon” is once again splattered across news headlines.
But what is the reality?
Corporate insolvencies have finally bounced back and are exceeding pre-covid levels. This is better described as a backlog rather than an Armageddon. In contrast, personal insolvencies, whilst having increased slightly since the pandemic, remain overall repressed. The increase is mostly due to business–related insolvencies, a legacy of ATO debt and expired Director Penalty Notices.
AFSA has projected total cases of personal insolvency for the 2023-2024 financial year to reach 12,250. This is well behind the 10-year annual average of 25,300.
Why are personal insolvencies not higher?
To understand the forces suppressing the current numbers, The Global Financial Crisis (GFC) and the period that followed can provide critical insights on the economic conditions that will trigger a spike in personal insolvencies.
The 2008 Global Financial Crisis
In 2008, Australia recorded 32,865 cases of personal insolvency. In August of 2009, unemployment reached 5.8% and persisted at that level for years. Between 2009 and 2019 the prices of goods and services increased by 23.4%.
Five years after the GFC, insolvency appointments increased by 39% (from the five years prior). Examination of this critical case study shows four key economic factors.
The four conditions that contribute to an increase in personal insolvencies
- High cost of living
Post GFC, the cost of living drastically increased, putting additional pressures on households to cut-back on discretionary spending. Similar cost of living challenges are evident in post-pandemic Australia.
- Reliance on credit
During periods of high cost-of-living or economic downturn, many individuals develop a dependency on credit to meet their expenses. Those who fail to cut back on discretionary spending are particularly vulnerable to financial difficulty. Over the 2023 Christmas period, more Australians begun to rely on credit cards to meet their expenses. In February 2024, $17.61 billion in credit card debt was accrued.
- Tough debt collection methods
Currently, individuals building up debt are benefitting from soft, flexible debt collection methods. Banks and other financial institutions are recovering enough repayments (and profit) to allow for this gentle approach. When default becomes more widespread, and profitability is jeopardised, debt collection will drastically change. This is also closely related to the unemployment rate.
- Rising unemployment
Unemployment is the fourth necessary condition to trigger an increase in personal insolvencies. Whilst a high cost of living and an increasing dependence on credit have already materialised, the unemployment rate in May 2024 remains low, at 3.8 per cent. Unemployment decimates household income, making mortgage repayments, the cost of living and debt servicing unmanageable.
Unemployment is also closely connected to antisocial behaviours, such as excessive alcohol consumption and gambling. It is not uncommon for individuals who suffer from these afflictions to find themselves insolvent.
The takeaway
Personal insolvencies will notably increase when employment significantly declines.