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Banks in Time of Covid-19: Loss Absorption Capacity, Lending and Market Valuation

Antonio Dicanio, Giuseppe Montesi
February 2021 - n. 2
Keywords: Bank Fragility, Bank Profitability, Bank Valuation, Loss Absorption Capacity, Capital Structure, Covid-19, Financial Regulation, Reverse Analysis
Jel codes: G01, G21, G28, G32

All over the world, governments, institutions and central banks have enacted massive actions in order to mitigate the effects of the Covid-19 pandemic on real economies and banking systems. This paper shows the extent of losses the banking systems of Germany, France, Italy, Spain, United Kingdom and Usa could bear thanks to their existing capital position and the relief measures recently taken by the Ecb, the Boe and the Fed. At the same time, we will show the amount of new lending that banks might grant to support the real economies based on capital constraints. Finally, we will investigate the relationship between financial stability, protection of public funds and profitability in the banking system. A key finding is that the banking systems are currently much better capitalized than at the beginning of the Global Financial Crisis in 2008-2009 and that they appear to be able to support the economy. Nevertheless, the banking sector seems to be facing a sort of trilemma (at least for the moment), i.e. the impossibility of simultaneously having: (1) A high level of capitalization and consequently stronger financial stability. (2) Protection of public funds. (3) Profitability capable of satisfying the cost of capital that allows banks to stay competitive.

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