The EU banking sector entered the post-Covid-19 economic crisis better capitalised than it was during the 2008 financial crisis. However, the persistence of the crisis in 2021 would profoundly affect the solvency of banks and the banking prudential framework in place at the European level may not be sufficient. These are the main conclusions of a study published on Tuesday 16 June by the EconPol Europe network of economic policy research institutes.
European banks could absorb the shock if the - “very (too) optimistic” scenario according to the study’s authors - of a “V-shaped” economic recession, with a sharp fall in GDP in 2020 and a rebound in 2021, as the IMF predicts. “But if the crisis were to continue beyond 2020, it is highly likely that major European banks would be hit by the crisis and that the current framework for bank resolution would then prove insufficient”, they add.
According to their calculation, given that total bank exposure amounts to 34,000 billion euros total and capital reserves are around 2,500 billion euros, banks would exhaust their entire capital base if “21%” of the loans granted to the economy were to become non-performing, without taking into account the depreciation of stock market securities held in investment portfolios.
The researchers point to the fact that the current crisis more closely resembles the Great Depression of 1929, when all sectors of economic life were affected, than the Great Recession observed after 2008. However, European prudential rules have been strengthened to ensure that banks are able to absorb a financial shock similar to that of 2008.
Benefiting from regulatory relief (see EUROPE 12501/1), banks are encouraged to maintain support to the economy through measures such as debt rescheduling, moratoria on loan repayments, liquidity support, zero or negative interest rate loans. “If the support offered by banks (...) were to last for long periods of time, capital reserves will become depleted and the Banking Union resolution mechanism agreed may be insufficient to provide a lifeline”.
The researchers estimate that in the event of a bank failure, the Single Resolution Fund (SRF), the financial arm of the resolution element of the banking union, could bail out financial institutions up to 42 billion euros, its endowment planned for the end of 2020. However, this sum, which corresponds to around 2% of bank capital in the EU, would not be “sufficient if several banking groups had to be recapitalized at the same time”, they warn.
If the SRF proves insufficient, the European Stability Mechanism (ESM), the Eurozone’s permanent rescue fund, could come into action. It is already in a position to bail out banks directly up to 60 billion euros. The reform of the ESM foresees that it will become, before 2024, the backstop of the SRF (see EUROPE 12505/16).
See the EconPol Europe study: https://bit.ly/3d8mBUw (Original version in French by Mathieu Bion)