A decade ago we learnt that the European project could not be taken for granted. History is not a one-way street. Triggered by the Great Financial Crisis, the continent was engulfed in the eurozone crisis, which pitched northerners against southerners in previously unimaginable ways. The crisis nearly ended with Greece leaving the eurozone – who knows what this would have meant for the future of the euro and the EU more generally. Since then the European project has been tested a few more times, most prominently during the refugee crisis in 2015 and then Brexit in 2016.
The Corona crisis – a repeat of the Great Financial Crisis?
The eurozone crisis had a lot to do with money – should the “prudent” northern Europeans help out the “profligate” southerners? A legacy of the crisis a decade ago has been the underperformance of European banks – the financial backbone of the European economies – with many struggling with balance sheets pulled down by non-performing loans.
Fast forward a decade and we find ourselves in what is to all intents and purposes an even bigger crisis. The economic collapse as a result of the Corona pandemic has been much deeper than what we experienced during the Great Financial Crisis. On a positive note, we might experience a more rapid recovery too, but this is by no means certain.
While the impact of the crisis on the real economy is obvious to all, what it could mean for European banking is not so clear.
Much will depend on the recovery we will get
European governments encouraged banks to keep on lending during the Corona crisis to the real economy by offering guarantees on new loans. Offering liquidity during stress was one of the policy lessons learnt from the Great Financial Crisis. But these guarantees do not cover existing loans, which make up a much larger part of banks’ loan books than any new loans offered over the last few months.
The future stability of European banks will thus crucially depend on how these existing loans will perform – and this will depend on the type of recovery we will experience.
A rapid recovery might mean few corporate defaults and banks might just about weather the storm. A drawn out recovery could spillover into the banking sector though and we should not be surprised to see a surge in defaults. In that case governments might have to step in yet again.
Old fault-lines might re-emerge, which would weaken the EU
While completely different in nature to the Great Financial Crisis and the eurozone crisis, the current Corona crisis might nonetheless affect countries in ways similar to those a decade ago. In particular, while all European banks improved their capital positions over the last decade, it appears that banking systems in northern countries might be in a better position than those in southern member states to deal with the fallout.
One can only hope that intelligent and far-sighted policy interventions on the national and European levels can prevent the worst case outcome. If not, we might experience a repeat of the stand-off between northern and southern Europeans we had a decade ago. If the EU wants to fight its corner on the world stage, it would be well advised to steer well clear of this.