European Banks Are Highly Exposed To The Current Crisis

To what extent will European banks withstand the current crisis? This is a crucial question because the recession we are experiencing could be followed by a banking crisis that would affect the whole economy even more severely. A CEPII study, entitled "European Banks and the Covid-19 Crash Test", sheds an interesting light on this subject. 

While a liquidity crisis seems unlikely, given that the European Central Bank is open for business, a solvency crisis cannot be ruled out, say the editors. They make a quick calculation: "The aggregate assets of eurozone banks amount to 34 trillion euros, of which 11.7 trillion are loans to the economy and 5 trillion are securities. With equity (capital and reserves) amounting to 2.5 trillion, it would only take 21% (11.7*21% = 2.5) of the loans not being repaid to exhaust them completely".

If one in five bank loans is not repaid, European banks crash; a scenario that is not unlikely in the event of a prolonged recession. All the more so as this calculation accepts a broad definition of capital (official, which comes from the banks) since leverage, or the "unweighted ratio" (ratio of capital to total assets without risk weightings), is shown in this study at 5.8% for eurozone banks. In his analyses, JP Chevallier advocates a stricter approach and calculates a leverage effect of around 1/40 for French banks, i.e. 2.5%, half the CEPII figure, which means that defaulting on around 10% of their loans would send French banks crashing .

This rate of 21% is not at all implausible, the study says, bearing in mind that "non-performing loans" (the official name for defaulted loans, which are not lost in full, however) were 8% in Italy in 2018, after having reached 15% in 2015. On average in the eurozone, they rose from 7% at the end of 2014 to 3% at the end of 2019. The countries most affected by the recession (France, Italy, Spain) could dangerously approach the red zone.

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