Working Paper: CEPR ID: DP14927
Authors: Moritz Schularick; Sascha Steffen; Tobias Tröger
Abstract: Do current levels of bank capital in Europe suffice to support a swift recovery from the COVID-19 crisis? Recent research shows that a well-capitalized banking sector is a major factor driving the speed and breadth of recoveries from economic downturns. In particular, loan supply is negatively affected by low levels of capital. We estimate a capital shortfall in European banks of up to 600 billion euro in a severe scenario, and around 143 billion euro in a moderate scenario. We propose a precautionary recapitalization on the European level that puts the European Stability Mechanism (ESM) center stage. This proposal would cut through the sovereign-bank nexus, safeguard financial stability, and position the Eurozone for a quick recovery from the pandemic.
Keywords: bank capital; financial stability; COVID-19
JEL Codes: G01; G20; E50
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| bank capital levels (G28) | loan supply (E51) |
| loan supply (E51) | economic recovery (E65) |
| bank capital levels (G28) | economic recovery (E65) |
| precautionary recapitalization (G28) | bank capital levels (G28) |
| bank capital levels (G28) | sovereign-bank doom loop (F65) |
| sovereign-bank doom loop (F65) | economic recovery (E65) |