The Shadow Value of Unconventional Monetary Policy

We quantify how central bank unconventional monetary policy, in the form of funding facilities, reduced the banking sector’s intrinsic fragility in the euro area in 2014-2021. We estimate a micro-structural model of imperfect competition in the banking sector that allows for multiple equilibria with bank runs, banks’ default and contagion, and central bank funding. Our framework incorporates demand and supply for insured and uninsured deposits, for loans to firms and households, and borrowers’ default. We use confidential granular data for the euro area banking sector, including information on banks’ borrowing from the European Central Bank (ECB). We document the presence of alternative equilibria with run-type features, but also that central bank interventions exerted a crucial role in containing this risk. Our counterfactuals show that, on average across equilibria, a 1 percentage point reduction in the ECB lending rate leads to a 1.4 percentage points reduction in banks’ default probability.