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Discussion Paper Details

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

Author(s): Henk Jan Reinders, Dirk Schoenmaker and Mathijs A Van Dijk

Publication Date: June 2020

Keyword(s): bank capital, Covid-19 pandemic, Financial Stability and stress test

Programme Area(s): Financial Economics

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 â?¬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.

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Bibliographic Reference

Reinders, H, Schoenmaker, D and Van Dijk, M. 2020. 'Is COVID-19 a threat to financial stability in Europe?'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=14922