Banking system resilience in the time of COVID-19

Capital cushions at European, UK, and US banks look adequate in most scenarios—and challenged in others. In either case, they must be rebuilt, and that will require some difficult decisions.

The recession of 2008–10 was triggered by a shock in the banking system. In fact, many economic downturns in the past 50 years, such as stock-market crashes and debt defaults, had financial-system origins. The current recession is different: it was triggered by a global pandemic, governmental and societal responses to it, and the resulting shocks to supply and demand.

But that does not mean that banking is not affected. The industry has already felt massive effects from the crisis, with more to come. And, as our colleagues have written recently, the banking systems in both Europe and the United States have roles to play in getting the economy back on track—for example, by providing loans to businesses that have suffered.

How effective a bank-supported economic recovery will be, however, depends on banks’ resilience and health. Losses from loan defaults and increases in risk-weighted assets will deplete banks’ capital. The extent will depend on the spread of COVID-19 and the effectiveness of the public-health response and mitigating interventions. Our new research considers three scenarios that business executives around the world consider most likely. We find that in two milder scenarios, in which GDP does not recover to its previrus level until 2021 or 2023, $100 billion to $400 billion in common equity tier-1 (CET1) capital would be wiped out in Europe, the United Kingdom, and the United States.

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