• banks
• credit default swaps
• credit risk
• high-frequency identification
• monetary policy
• monetary policy shocks
• Proxy SVAR
• SVAR-IV

The recent shift to a tighter monetary policy environment has brought renewed focus on how banks, as key financial intermediaries in the Euro Area, are responding. Using a Proxy-SVAR approach, I investigate on a 2008-2023 sample how Euro Area bank stability reacts to unexpected monetary policy shocks, employing as exogenous monetary surprise series a high-frequency identified "target" factor. To measure bank risk, credit default swap (CDS) indexes are constructed, distinguishing by maturity and debt seniority. CDS are a forward-looking measure reflecting how financial markets perceive current and future bank credit risk.
The monthly and daily frequency structural VAR analysis shows that an exogenous restrictive monetary policy shock increases perceived banks' current and potential future risk, when controlling for the level of economic activity and investor sentiment measured by the corporate bond credit spread. The negative estimated effect holds regardless of maturity and seniority characteristics, although the impact is significantly larger in magnitude for the 1-year subordinated CDS index.
An interpretation of these results is provided. Higher interest rates are positively associated with net interest margins, which boosts bank net interest income. However, tighter monetary policy can enhance some downside risks for the banking sector, especially over time: a worsened macroeconomic outlook, via the rise in non-performing loans and decline in intermediation volumes; higher funding costs and tighter liquidity; capital losses on fixed-income assets held in banks' portfolios; exposure to vulnerable sectors, such as real estate.