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Structural and cyclical capital instruments in the 3D model: a simulation for Portugal

Diana Lima
Duarte Maia
Ana Pereira
Ano de Divulgação 
Código JEL 
E3 - Prices, Business Fluctuations, and Cycles
E44 - Financial Markets and the Macroeconomy
G01 - Financial Crises
G21 - Banks; Other Depository Institutions; Mortgages
O52 - Europe
In this study, we assess the effectiveness of structural and cyclical capital requirements under distinct sources of disturbance. The analysis is based on the model of Clerc et al. (2015) with three layers of default (3D model) calibrated for the Portuguese economy. We conclude that an increase in capital requirements, regardless of their structural or cyclical nature, enhances the resilience of the banking sector to adverse shocks and reduces the impact of those disturbances on the well-functioning of the banking sector. Nonetheless, results also indicate that capital requirements can be more effective if the distress emerges from within the financial system, corroborating the idea that prudential policies are not meant to be the first line of defense to address all types of shock. Countercyclical capital buffers also help counter some of the pro-cyclicality in the financial system by smoothing the crunch in credit flows. Structural and cyclical capital instruments can be considered as strategic complements as they reinforce each others’ policy goals.
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