ECB Monetary Policy and the Term Structure of Bank Default Risk

Round 1

Reviewer 1 Report

Review Report(jrfm-2715184): ECB monetary policy and the term structure of bank default risk

This paper investigates the ECB monetary policy and the term structure of bank long and short-term default risk captured by CDS spreads. The authors exploit Svensson’s (1994) method to explain the shape of the default risk curve relating bank default risk loadings to major economic events. The authors follow Rigobon and Sack (2004) to depict event-triggered ECB monetary policy shocks. Using fixed effect panel models, the authors distinguish between term effects impacts of monetary policy on default risk in tests of proposed hypotheses. Additional empirical tests focus on core vs. periphery differences for banks covered by the sample and the effects of deposits, amongst other tests. Overall, the authors find, for specific periods, that expansionary policy diminished bank risk in the short term. This effect was pronounced during the sovereign debt crisis affecting the EU. While these effects do not hold for the long term, they could be linked to excessive risk-taking behavior, which seems to be the case for banks relying more on deposit funding. The authors also report other empirical results.

My take on this paper is that it is well-written and executed.  It is also a nice read. It expands the findings of Soenen and Vennet (2022), given some variations in the approach and empirical results, although there are some similarities.

My recommendations to the authors are as follows:

1-     Keep a separate introduction with a short motivation, research problem identified contribution, and how the approach and findings differ from similar papers such as Soenen and Vennet (2022). This adds value to the paper as these points could be easily identified.

2-     Keep a separate literature review and hypotheses development sections.

3-     Explain why the sample of banks is chosen. Footnote 2 is not clear, as most banks engage in financial intermediation. Are there other criteria for sample selection?

4-     Show results with time-fixed effect; for example, in Tables 3 and 4.

5-     Which deposits are the authors referring to? All deposits or deposits for particular terms.

6-     The sample includes some banks from the Latin part of Europe, which had recurring difficulties during the sample, and at times, some German banks had difficulties too. Regardless of the region, would the results be robust for high and low bank default risk?

I hope that these comments will be helpful to the authors.

Best wishes.

Author Response

Please see the attachment

Author Response File: Author Response.pdf

Reviewer 2 Report

I only have minor comments:

1/abstract : add the period under review : 2011-2021, as MP has, since that period, entered into a tightening phase;

2/ there is a concern that the CDS markets lacks liquidity, in addition, the market only deals with large banks, as well as listed banks (Credit Agricole in CASA, not the whole group), while a large fraction of European are cooperative or mutual. German savings banks are not in the sample. This should be stressed, as it limits the conclusions.

3/ Figure 2 and 3 should be much better explained. Figure 2 are across banks, while Figure 3 are time series?

4/ although the core-periphery is addressed, the authors could have investigated the fragmentation risk, which has been stressed at some occasions by the ECB. See Monetary policy, fragmentation risks and the euro | Banque de France (banque-france.fr)

5/ in 4.4, LIQUIDITY DEPENDENCE AND THE WAXING AND WANING OF CENTRAL BANK BALANCE SHEETS by Viral V. Acharya,  Rahul S. Chauhan, Raghuram Rajan and Sascha Steffen (NBER WP, March ) for the US could be mentioned, studying the increase in uninsured deposits associated with the increase in banks' reserves.

Author Response

See the attachment

Author Response File: Author Response.pdf