From SMP to PEPP: a further look at the risk endogeneity of the Central Bank

This paper examines the evolution of credit risk arising from monetary policy operations and ELA on the Eurosystem balance sheet over the last decade. We employ a dynamic, market-driven risk model relying on the expected default frequencies for sovereigns, banks and corporates provided by Moody’s Analytics. Dependence between defaults is modeled with a multivariate Student t distribution with time-varying parameters. We find that at the end of 2020, risk is slightly above its average value in 2010 and approximately equal to one quarter of the value measured at the peak of the sovereign debt crisis in 2012, notwithstanding the threefold increase in the Eurosystem monetary policy exposure occurred since then. This is due to the launch of the OMT and PEPP, which succeeded in quelling market turmoil, thereby reducing the Eurosystem’s own balance sheet credit risk. The OMT in particular has had a long lasting effect in lowering sovereign risk in the euro area. Our findings support the view that, in periods of severe financial distress, risk for a central bank is largely endogenous.