Economic Uncertainty, Public Debt and Non-Performing Loans in the Eurozone: Three Systemic Crises

Recent systemic crises, from the Global Financial Crisis (GFC) to Covid19 pandemic, have put geoeconomics uncertainty to the forefront of financial services strategic decision-making and operational planning. Yet, to-date, research connecting economic policy uncertainty to banking sector risks and performance metrics is lacking. This paper examines the relationship between the Economic Policy Uncertainty (EPU) Index on the non-performing loans (NPLs) across 19 Eurozone member states, using panel data for 194 banks during the 2001-2021 period. As the crises covered were endogenous to the banking sector regulatory and operational environments, we introduce a novel control for the interaction between crises severity and duration, as well as banking sector strategic and operating environment. This control is proxied by public debt levels reflective of fiscal deficit measures deployed to ameliorate effects of the crises. We find that rising EPU during the crises is associated with higher NPLs and lower government debt. We also document how this relationship is changing over time and across crises.