Profitability shocks and recovery in times 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.