Is COVID-19 a Threat to Financial Stability in Europe?

28 Pages Posted: 29 Jun 2020

See all articles by Henk Jan Reinders

Henk Jan Reinders

Rotterdam School of Management; Dutch Central Bank (DNB)

Dirk Schoenmaker

Rotterdam School of Management, Erasmus University; Erasmus Research Institute of Management (ERIM); Centre for Economic Policy Research (CEPR)

Mathijs A. Van Dijk

Erasmus University - Rotterdam School of Management; Erasmus Research Institute of Management (ERIM)

Multiple version iconThere are 2 versions of this paper

Date Written: June 2020

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: bank capital, Covid-19 pandemic, Financial Stability, stress test

JEL Classification: G01, G21, G28

Suggested Citation

Reinders, Henk Jan and Schoenmaker, Dirk and Van Dijk, Mathijs A., Is COVID-19 a Threat to Financial Stability in Europe? (June 2020). CEPR Discussion Paper No. DP14922, Available at SSRN: https://ssrn.com/abstract=3638026

Henk Jan Reinders (Contact Author)

Rotterdam School of Management ( email )

Dutch Central Bank (DNB) ( email )

P.O. Box 98
Amsterdam, 1000 AB
Netherlands

Dirk Schoenmaker

Rotterdam School of Management, Erasmus University ( email )

P.O. Box 1738
Room T08-21
3000 DR Rotterdam
Netherlands

HOME PAGE: http://www.rsm.nl/people/dirk-schoenmaker/

Erasmus Research Institute of Management (ERIM) ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Mathijs A. Van Dijk

Erasmus University - Rotterdam School of Management ( email )

P.O. Box 1738
Rotterdam, 3000 DR
Netherlands
+31 10 408 1124 (Phone)
+31 10 408 9017 (Fax)

HOME PAGE: http://mathijsavandijk.com/

Erasmus Research Institute of Management (ERIM)

P.O. Box 1738
3000 DR Rotterdam
Netherlands

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