Working Paper: CEPR ID: DP14922
Authors: Dirk Schoenmaker; Henk Jan Reinders; Mathijs A. van Dijk
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
JEL Codes: G01; G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| COVID-19 (I15) | financial stability (G28) |
| COVID-19 (I15) | expected loan losses (G33) |
| stock price shocks (G14) | default probabilities (C25) |
| default probabilities (C25) | expected loan losses (G33) |
| COVID-19 (I15) | market-implied losses (G33) |
| economic shocks (F69) | market valuations (G19) |