Covid-19 Pandemic and Belgian financial stability: an approach to measure the impact of the crisis on the belgian banking system

Abstract

The objective of this master's thesis is to study and assess the impact of the Covid-19 crisis on the stability of the Belgian banking system. To do so, the method implemented by Reinders et al. (2020) measuring the estimated additional losses in the portfolio of European banks is applied at the Belgian level. This model allows to evaluate the amount of losses of banks in their corporate loan portfolio by determining the changes in the probability of these companies to be in default. To estimate these changes in default probability a Black and Scholes (1973) and Merton (1974) model is used to measure the impact of an asset valuation shock in the value of the equity and the debt of a firm. The model developed allow us to calculate changes in the probability of default for the 111 publicly traded firms in the sample based on their stock market data responses between March 17, 2020, when the crisis peaked, and June 30, 2021, when data was last available. Once the change in probability of default obtained we were able to compute the potential losses in Belgian banks corporate loans portfolio by multiplying this change of the probability of default to the exposure at default of the banking sector as well as the loss given default. Our findings point to a few key conclusions. The first is that at the peak of the Covid-19 crisis, losses in banks' corporate loan portfolios were substantial, ranging from 7.45 percent to 37.66 percent of total corporate loan exposures according to various scenarios resulting from the pandemic's impact on both equity volatility and loss given default. The second is that the stability of the Belgian banking sector appears to have been established, as well as the efficacy of monetary and fiscal assistance measures. Indeed, compared to the peak of the crisis, additional predicted losses as of June 30, 2020 have been considerably decreased to represent only a small fraction of total corporate loan exposures. As a result, this analysis gives an estimate of the banks' potential losses and allows them to be evaluated for solvency. The approach described here may be useful for bank supervisory organizations to assess the impact of the Covid-19 shock for the business sector reflected on banks' balance sheets and take appropriate measures to ensure financial stability while keeping credit available to real-economy actors.