ECB Monetary Policy and the Term Structure of Bank Default Risk

We investigate the association between ECB monetary policy and market-perceived short- term and long-term bank risk, using the term structure of default risk captured by bank CDS spreads. During the period 2009-2020, ECB expansionary monetary policy diminished bank default risk in the short term. However, we do not observe a similar decline in long-term bank default risk, since monetary stimulus is associated with a steepening of the bank default risk curve. The reduction of bank default risk is most pronounced during the sovereign debt crisis and for periphery Euro Area banks. From 2018 onwards, monetary policy accommodation is associated with increased bank default risk, both short term and structurally, consistent with the risk-taking hypothesis under which banks engage in excessive risk-taking behavior in their loan and securities portfolios to compensate profitability pressure. The increase in perceived default risk is especially visible for banks with a high reliance on deposit funding