Profitability shocks and recovery in time of crisis evidence from European banks

This paper contributes to the existing literature on bank crisis and bank profitability by shedding light on “profitability shock” (i.e. a sudden and sizeable decline in profitability) and “profitability recovery” (i.e. returning to the previous level). Using a sample of 109 European bank holding companies over the years 2006-2016, we investigate the main drivers of these profitability shocks and the factors allowing banks to regain profitability and avoid a more severe crisis. Our findings show that (1) the profitability crisis has its roots in the lending activity and in the deterioration of the loan portfolio caused by a strong risk appetite that is not counterbalanced by adequate loan loss provisions and capitalization; (2) banks that recover after the profit shock adopt a more conservative lending policy, reduce their credit offer and tackle more effectively the NPL issue.