Financial stability: a ‘vaccine’ for tail risk of the global banking sector in the shadow of the pandemic

Abstract

This study examines the association between bank tail risk and the ongoing COVID-19 pandemic. We use a sample of 868 listed banks across 98 countries from 2002 to 2020, yielding a cross-country panel sample of 15,791 bank-year observations. We find that different components of bank tail risk (i.e. systematic and idiosyncratic) have increased during the health crisis but less so for stronger banks (i.e. more profitable, higher market valuation, lower stock volatility). The result implies that the pandemic results in a higher possibility of suffering extremely large losses in the stock prices of the global banking sector. However, banks with higher profitability and financial stability levels can better prepare themselves to tackle the crisis more effectively and hence are less likely to suffer extreme equity devaluations. Therefore, we contend that financial stability acts as a ‘vaccine’ for the bank tail risk in the shadow of the pandemic. We finally confine the results to some specific geographic settings; typically, they are more intensified in countries with more financial freedom, middle income-generating, and large banks.