The impact of COVID on European banks
In this post, Constantin Gurdgiev cites a recent McKinsey study which forecasts that a muted recovery in Europe would lead to a 40% drop in European banks’ revenue as well as a drop of 11% in ROE by 2021. In addition, the pandemic has accelerated structural trends such as high digital engagement levels and a significant decrease in the use of cash for which many European banks are not prepared for. Against this background, it is banks operating in the 2008-2014 crises-hit economies, such as Ireland, Italy, Spain and Portugal, that might be the most vulnerable.
COVID19 and European Banking
By: Constantin Gurdgiev – Trinity College Dublin
The risk of defaults
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. It would then be possible to mobilise the European Stability mechanism. Should this instrument prove insufficient, the risk of the re-emergence of a sovereign debt crisis would increase.
European Banks and the Covid-19 Crash Test
Authors: Jézabel Couppey-Soubeyran, Erica Perego, Fabien Tripier
From: CEPII
Do provisioning rules make things worse?
The rules that dictate the way banks provision for loan losses are crucial because they directly affect the ability of banks to continue lending to the real economy.
- Before the financial crisis these rules relied on the concept of “incurred loss” and were blamed for excessively delaying the recognition by lenders of credit losses;
- As a result, after the financial crisis, new accounting standards were established which rely on the concept of “expected credit loss” i.e. financial institutions are required to provision for expected future credit losses using all information available.
Since the outbreak of the COVID crisis, bankers have feared that the application of the new expected loss models may lead to a sudden significant increase in credit loss provisions, which would result in an erosion of banks’ capital. But these concerns, argues Lucas Mahieux, are only valid if prudential regulators set banks’ capital requirements independently of the accounting standards used to provision for loan losses. This is not the case neither in the US nor in Europe where policymakers have acknowledged the connection between accounting rules and capital requirements: as a result, although European banks must provision for “expected credit losses”, they are also likely to face looser capital requirements in the next few years.
Bank loss provisioning rules: a convenient scapegoat in the Covid-19 crisis?
By: Lucas Mahieux – Tilburg University
