Is COVID-19 a threat to banks and financial stability in Europe? And which economic sectors are hit hardest by the COVID-19 crisis? Prof. Mathijs van Dijk, Prof. Dirk Schoenmaker and Henk Jan Reinders from Rotterdam School of Management, Erasmus University (RSM) have been awarded a ZonMW grant of €79,930 to investigate answers to these questions. The grant is part of a subsidy by the Dutch Ministry of Health, Welfare and Sport and national research organisation NWO: ‘Covid-19 Societal Dynamics’. It is awarded for short-term research aimed at the societal effects of the corona pandemic and of the possible policy measures to mitigate these effects. The proposed research aims to provide an up-to-date assessment of expected loan losses for European banks using real-time market valuations to determine the impact of COVID-19 on Europe’s financial stability
COVID-19 impact assessment on banks
The COVID-19 pandemic has a severe but uncertain impact on the global economy. The IMF projects the global economy to shrink by five per cent in 2020, which is more than during the ‘Great Recession’ in 2008-2009. The impact on the banking sector will be an important factor in determining how long-lasting and severe the COVID-19 recession will be.
Banks have a central role in the economy. The economic damage will be much greater if banks are hit hard and financial stability is undermined. But assessing the impact of COVID-19 on banks’ loan portfolios is a major challenge, as such assessments are usually based on slow-moving accounting data. There needs to be a timely assessment of expected loan losses – based on market valuations rather than accounting numbers – to evaluate which policy measures are needed now to safeguard banking sector stability.
The researchers’ hypothesis is that banks’ current loan loss provisions based on accounting rules severely underestimate the actual expected losses in their loan portfolios. Using real-time market valuations will provide a much more up-to-date assessment of actual expected loan losses. The research outcomes will be of immediate interest to financial regulators and supervisors, who will need to act quickly if the stability of the financial sector is at stake. The option valuation approach of Nobel laureate Robert Merton will be used to assess expected loan losses for banks in Europe based on real-time stock market data. The researchers will estimate increases in default probabilities due to the COVID-19 crisis for 1,981 publicly listed firms in 19 economic sectors in the euro area, and subsequently evaluate the potential impact on the balance sheets of euro area banks under different scenarios.
Rotterdam School of Management, Erasmus University (RSM) is one of Europe’s top-ranked business schools. RSM provides ground-breaking research and education furthering excellence in all aspects of management and is based in the international port city of Rotterdam – a vital nexus of business, logistics and trade. RSM’s primary focus is on developing business leaders with international careers who can become a force for positive change by carrying their innovative mindset into a sustainable future. Our first-class range of bachelor, master, MBA, PhD and executive programmes encourage them to become critical, creative, caring and collaborative thinkers and doers. www.rsm.nl
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