Prudential policy treatments to the COVID-19 economic crisis: an assessment of the effects

At the onset of the COVID-19 pandemic shock, several policy measures were adopted to mitigate the severe effects on economic and financial activities. In this paper we focus on the assessment of the economic and financial impacts of prudential policy measures, namely the flexibility measure – i.e. a temporary relaxation of the Pillar 2 Guidance and the combined buffer requirement – and the dividends pay-out restriction. As the economy recovers from the pandemic crisis and measures are being withdrawn, we are also interested in understanding the implications of distinct paths for the replenishment of capital buffers. For these purposes we use a dynamic general equilibrium model with banks, households and firms default, calibrated for the Portuguese economy. Our main conclusions are that the measures were effective in achieving their main policy objectives of maintaining the credit flow in the economy. Importantly, results also suggest that the joint use of the flexibility measure and the dividends pay-out restrictions reinforces the benefits that were achieved by using the flexibility measure only. We also show that the joint use of measures reduce the effort of the banking system to rebuild their capital buffers once the pandemic crisis vanishes. Lastly, transition periods for the replenishment of capital buffers should be carefully considered, since shorter transition periods may be more effective at reinforcing banks’ resilience, but longer transitions may be more adequate for ensuring that lending flows smoothly to the economy.