Rising risks

By David Born

Predicting the end of a credit cycle is difficult - if not impossible. Yet amid an intensifying backdrop of geopolitical conflict, the conditions for credit financing are becoming noticeably more challenging. Businesses should, therefore, brace for higher effective borrowing costs, particularly on riskier loans. Collateral and reporting requirements are also set to tighten. In practice, that implies more conservative asset valuations, greater reliance on personal and corporate guarantees, and steeper haircuts on illiquid or higher-risk collateral.

Banks in the euro area, the United States and Japan have already been tightening lending standards for five consecutive years. Their latest bank lending surveys point to lower risk tolerance, a weakening economic outlook and rising sector- and firm-specific risks as the main drivers. In the United States, concerns are also growing over a tentative cooling of the AI-driven boom and the financial resilience of certain borrowers.

According to the European Central Bank’s most recent report, credit standards in the euro area are expected to tighten further this quarter - even as corporate loan demand has edged up by 3%. In line with that trend, rejection rates, particularly for larger companies, continue to rise.

The war in Iran has reignited fears of stagflation. Early indicators suggest that inflation may prove more persistent than policymakers had anticipated. In the United States, core producer price inflation rose to 3.9% in February. Europe offers little comfort: services inflation - a key gauge of domestic price pressures - has remained well above the European Central Bank’s 2% target for the past three years, reaching 3.4% in February. The potential impact of a further price shock from higher energy costs and disrupted supply chains has yet to be fully reflected.

As a result, expectations of deep interest-rate cuts by the Federal Reserve and other major central banks are beginning to fade. Bond markets are even starting to price in rate hikes for 2026. For corporate borrowers, this presents a particular challenge. Financing conditions remain closely tied to 10-year sovereign bond yields. In other words, if government bond yields rise, corporate borrowing costs will follow - often by more.

Increasing liquidity pressure as monetary headwinds intensify

These challenges come at a time when the global financial system is undergoing a structural shift. In its latest quarterly report, the Roland Berger Institute highlights three forces shaping the current landscape:

First, the unprecedented expansion of sovereign debt has reshaped the pricing of risk, effectively setting a higher floor for interest rates. The scale of US federal debt illustrates the point. At USD 38.3trn, it is imposing an increasing fiscal burden, with debt servicing costs projected to reach USD 1.23trn in 2025 - approaching the size of the defence budget. To attract sufficient demand for this volume of issuance, the US government must effectively sustain 10-year Treasury yields at around 4.2%, thereby repricing borrowing costs across the economy.

Second, capital is becoming increasingly concentrated in AI-linked assets, reshaping equity valuations. The current AI rally has been fueled in part by US margin debt reaching a record USD 1.2trn, highlighting the extent of leveraged positioning. The imbalance is structural: the Magnificent Seven now represent 34.75% of the S&P 500, with passive inflows accounting for 55% of the market, mechanically channeling capital into these crowded names. This backdrop shifted abruptly in March. Investors’ cash allocations, which hit a historic low of 3.2% in February, surged to 4.3% within a week - an unusually sharp move pointing to a rapid reassessment of risk and a potential mechanical stampede.

Third, signs of strain are emerging in private markets, where leveraged structures are coming under pressure from tighter monetary policy and a looming wave of corporate refinancing. With nearly USD 2.98trn in corporate debt approaching maturity in 2028, borrowers are being forced back into capital markets under far less forgiving conditions. The refinancing process is triggering a reset in valuations, as underlying assets are marked down to reflect the impact of higher discount rates on future cash flows.

How companies should prepare

Companies reliant on new credit or refinancing in the coming months will need to rethink their approach. Growth assumptions must be grounded in realism rather than optimism, as lenders increasingly discount strategies tied to uncertain macroeconomic recoveries or regulatory shifts. Credibility is enhanced when companies prioritize high-return, short-payback investments and align forecasts with conservative industry outlooks within integrated, scenario-based planning frameworks.

Credit assessment has shifted towards resilience under adverse conditions, with lenders focusing as much on downside scenarios as on base-case performance. In this context, reducing earnings volatility and improving predictability can be as important as lowering absolute leverage.

Cash flow has become the defining metric of financial strength, with lenders placing greater emphasis on free cash flow than on EBITDA. Detailed forecasts that incorporate downside scenarios, credible countermeasures and a clear liquidity horizon of 12 to 18 months are now essential to securing confidence.

Transparency in capital structure is increasingly central to building trust with creditors and investors. Clearly articulated leverage strategies, visible liquidity buffers and well-explained risk mitigation measures - alongside stronger positioning of intangible assets - form the foundation of resilient financing relationships.

We would like to thank Christian Gschwendtner and Yu Wang for co-authoring this study.

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