Is COVID-19 a threat to financial stability in Europe?

Dirk Schoenmaker, Henk Jan Reinders and Mathijs Van Dijk

No 14922, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: The severe economic impact of the COVID-19 pandemic could threaten financial stability. However, assessing the gravity of this threat is challenging, since banks’ accounting-based loan loss provisions are sluggish. We use a Merton contingent claims model to provide a real-time, market valuation-based assessment of the impact of COVID-19 on euro area banks’ corporate loan portfolios. We calibrate the model based on observed stock price responses and use different scenarios for future volatility and incurred losses in case of default. Based on stock prices as of April 20, 2020, we estimate that the market-implied losses for euro area banks could reach over €1 trillion, or 4 to 25% of corporate credits’ book value (7 to 43% of available capital and reserves). Our analysis can be viewed as an early warning indicator of potential accounting losses to follow.

Keywords: Covid-19 pandemic; Stress test; Financial stability; Bank capital (search for similar items in EconPapers)
JEL-codes: G01 G21 G28 (search for similar items in EconPapers)
Date: 2020-06
New Economics Papers: this item is included in nep-ban and nep-rmg
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Citations: View citations in EconPapers (9)

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