In an extremely unfavorable scenario, the complex system of interconnections between real activities, banks and sovereigns means that initial corporate necrosis can spread rapidly, triggering a fundamental re-pricing of risk in a new 'ruin loop'. (Figure 17). Just a few defaults in some important and highly connected sectors can quickly grow into a torrent, with sudden loss realizations shaking capital markets and reverberating through corporate-financial-sovereign feedback loops. It may cause a system crisis.
Assuming conservative default rates seen in past crises, we can expect a cumulative default rate of 10% over the next two years in this extreme scenario.. This means that the number of bankruptcies will skyrocket based on the current annual default probability of less than 1%. Under these assumptions, corporate sector losses would wipe out about three years of bank profits (Figure 18). Banks will respond by cutting their riskiest loans to preserve capital. Usually to small businesses that need the money the most. Given the sovereign exposure to companies, the public sector will also bear losses, including on average up to 5% of GDP from direct losses and lost corporate tax revenues, which will remain This will significantly cut into the limited policy space (Figure 18). In this situation, the eurozone would be plunged into a prolonged recession, but this time with rising debt and minimal policy space for further fighting.
Although this scenario remains extreme, it highlights the need for euro area financial sector policy to be more proactive regarding potential corporate sector risks. This is particularly true in some countries, where slowing bankruptcies and declining asset recoveries threaten to compound economic scars, weaken financial systems and erode valuable policy space. Reducing insolvency ex post requires faster, more efficient and more robust debt resolution frameworks, including simplified insolvency procedures for small and medium-sized enterprises, hybrid restructuring mechanisms and out-of-court resolutions. It is.
Preemptive policy must include the immediate completion of the banking union. Despite single banking supervision and resolution, the banking union remains incomplete and risks potential fragmentation in times of stress. Efforts to close key gaps, such as the design and implementation of the European Deposit Insurance System (EDIS), have lost momentum in recent years, and new efforts are needed to foster consensus and the expansion of cross-border banking. Become. The European Commission has adopted a proposal to adjust and further strengthen the EU's existing Banking Crisis Management and Deposit Insurance (CMDI) framework, with a focus on smaller and medium-sized banks. It ignores the role of institutional protection systems. and the importance of EDIS (also the resolution) to complete the banking union.
