In addition, if people increasingly tend to judge the soundness of a financial institution simply by looking at the level of capital on the balance sheet – in other words, looking at the capacity to absorb future losses rather than the earning growth potential –, a financial institution could face a paradoxical situation.
This, in turn, increases the probability of corporate defaults Indeed, rating agencies are predicting a surge in defaults by both US and euro area speculative-grade firms in the near term. Past experience also strongly suggests that the persistent and substantial rise in oil prices can further contribute to a higher probability of corporate defaults.