European Banks and the Covid-19 Crash Test
The Covid-19 crisis is not a financial crisis but it can become a serious test for European banks’ strength and resilience: they are stronger today than they were on the eve of the 2007-2008 financial crisis, however the Covid-19 shock more closely resembles the Great Depression of the 1930s. This policy brief from Jézabel Couppey-Soubeyran (EconPol Europe, University Paris 1 Panthéon-Sorbonne, CEPII), Erica Perego (EconPol Europe, CEPII) and Fabien Tripier (EconPol Europe, Université Paris-Saclay (Univ. Evry), CEPII) presents the problems that the Covid-19 crisis poses to banks, the proposals currently under discussion and the decisions taken to date by the monetary and prudential authorities. It highlights the fragility of the current prudential framework and the inadequacy of the resolution mechanism, which will require additional resources if the banking crisis cannot be avoided.
European banks are stronger today than they were on the eve of the 2007-2008 financial crisis, thanks to the reforms that have taken place since then. But will they be strong enough in the face of a health crisis closer to the Great Depression of the 1930s than the stress scenarios envisaged by the European banking Authority for 2020? Access to central bank liquidity probably eliminates the risk of bank illiquidity, but it is not unthinkable that a bank insolvency crisis would have to be managed. The non-repayment of one in five loans would be enough to exhaust the current level of capital. The resolution mechanism would then have to be mobilised, which is unlikely to be sufficient in a context where, according to the European Systemic Risk Board, the risk of simultaneous defaults is increasing sharply. This would leave the possible mobilisation of the European Stability Mechanism. If this complement proves insufficient, a sovereign debt crisis in the euro area could re-emerge.
Jézabel Couppey-Soubeyran, Erica Perego, Fabien Tripier: European Banks and the Covid-19 Crash Test, EconPol Policy Brief 30, May 2020