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The Covid-19 Pandemic, Sovereign Loan Guarantees, and Financial Stability

Ivan De Lorenzo Buratta
Tiago Pinheiro
Publication Year 
JEL Code 
E3 - Prices, Business Fluctuations, and Cycles
E44 - Financial Markets and the Macroeconomy
G01 - Financial Crises
G21 - Banks; Other Depository Institutions; Mortgages
O52 - Europe
We analyze the effects of the Portuguese COVID-19 sovereign loan guarantee scheme on financial stability using a DSGE model. Sovereign loan guarantees decrease the default rate of banks, increase credit, and speed up economic recovery. On the other hand, guarantees increase the leverage and default rate of firms. These effects are larger the lower the sensitivity of the capital of banks to capital requirements. Behind these results are the reduction in regulatory risk-weights and the transfer of loan losses from banks to the sovereign brought by sovereign loan guarantees.
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