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

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  • Schoenmaker, Dirk
  • Reinders, Henk Jan
  • Van Dijk, Mathijs

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.

Suggested Citation

  • Schoenmaker, Dirk & Reinders, Henk Jan & Van Dijk, Mathijs, 2020. "Is COVID-19 a threat to financial stability in Europe?," CEPR Discussion Papers 14922, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:14922
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    References listed on IDEAS

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    RePEc Biblio mentions

    As found on the RePEc Biblio, the curated bibliography for Economics:
    1. > Economics of Welfare > Health Economics > Economics of Pandemics > Specific pandemics > Covid-19 > Economic consequences > Finance and credit

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    Cited by:

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    2. Peter A.G. van Bergeijk, 2021. "Pandemic Economics," Books, Edward Elgar Publishing, number 20401.
    3. Wenbo Wang & Hail Park, 2021. "How Vulnerable Are Financial Markets to COVID-19? A Comparative Study of the US and South Korea," Sustainability, MDPI, vol. 13(10), pages 1-18, May.
    4. Deimantė Teresienė & Greta Keliuotytė-Staniulėnienė & Rasa Kanapickienė, 2021. "Sustainable Economic Growth Support through Credit Transmission Channel and Financial Stability: In the Context of the COVID-19 Pandemic," Sustainability, MDPI, vol. 13(5), pages 1-34, March.
    5. Byström, Hans, 2021. "Credit Risk in a Pandemic," Working Papers 2021:1, Lund University, Department of Economics.
    6. Dirk Ehnts & Michael Paetz, 2021. "COVID-19 and its economic consequences for the Euro Area," Eurasian Economic Review, Springer;Eurasia Business and Economics Society, vol. 11(2), pages 227-249, June.
    7. Zbigniew Korzeb & Paweł Niedziółka, 2021. "Determinants of Differentiation of Cost of Risk (CoR) among Polish Banks during COVID-19 Pandemic," JRFM, MDPI, vol. 14(3), pages 1-12, March.
    8. Piotr Lasak, 2021. "The Commercial Banking Sector in Eurozone after the Pandemic: The Paths to Recovery," European Research Studies Journal, European Research Studies Journal, vol. 0(Special 1), pages 1233-1246.

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    More about this item

    Keywords

    Covid-19 pandemic; Stress test; Financial stability; Bank capital;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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