Is COVID-19 a threat to banks and financial stability in Europe?

The COVID-19 pandemic has a huge impact on the economy. The global economy is expected to shrink by as much as 5% in 2020, even more than during the 2008-2009 financial crisis. The length and depth of this recession will largely depend on the impact of COVID-19 on banks, given their central role in the economy. However, this impact is difficult to assess, because banks estimate the losses on their outstanding loans based on outdated accounting data. Banks and regulators urgently need an up-to-date estimate of expected losses from COVID-19 so that they can take measures if financial stability is at risk. In this project, a new method is being developed to estimate these losses in real-time based on market valuations and the option valuation model of Nobel Prize winner Robert Merton. The method is applied to European banks and the market valuations of 1,981 European listed companies in 19 sectors.