The policy paper reviews the policy interventions that EU institutions and governments put in place to reduce the risks of lockdown and the halting of economic activity. It assesses the consequences of COVID-19 on the banking sector in Europe, in terms of capital, asset quality, liquidity and profits. It also provides a proposal on how to build a recovery path for banks and for the real economy in Europe post-COVID-19. To do so, the paper analyses the evolution of banking risk and proposes avenues on ways to manage the possible worsening of the credit quality of bank loan portfolios, depending on both the residual amount of NPLs that European banks hold in their balance-sheets and the effect of the COVID-19 crisis on the real economy. In particular, the paper discusses a hybrid approach that includes: i) the creation of a Eurozone Bad Bank to manage the future increase in non-performing loans (NPLs), and ii) the implementation of a European pandemic equity fund to support firms that are not defaulting.
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