Ban on bank dividends: a strange remedy with heavy side effects

The restrictions on bank dividends, in effect since March 2020, are expected to end this summer. For the banks and their shareholders, this is a relief. The measure, supposed to protect banks in the face of the crisis, has done them more harm than good. Technically, dividends from the banking sector made a big comeback in the spring of 2021. However, the amounts paid remained well below their 2019 levels, given the still numerous restrictions. The return to normal will have to wait for the results of the banking stress tests, published on July 31 by the European Banking Authority. If these prove to be conclusive for most institutions, as expected, the ECB will finally be able to lift the restrictions that have applied since the start of the health crisis. The abolition of dividends, an awkward alarm signal On March 27, 2020, the European Central Bank indeed “recommended” to the banks of the euro zone to suspend the payment of their dividends, including when these had been announced of long time. The goal ? Preserve their own funds to protect their solvency in the event of a deep economic crisis. The ECB believed at the time that the Covid-19 pandemic would result in a collapse in bank capital. The massive financial support given to businesses and individuals during the crisis helped avert the dreaded wave of defaults. Regulatory capital levels have managed to remain broadly stable throughout 2020. On the other hand, the ban on dividends has had a very real effect on the stock prices of banking institutions. After their initial fall in February-March, they accentuated their decline until May 2020, or even until the fall, against the trend of the market rebound. The elimination of dividends was indeed a worrying signal of distress for the sector. In a banking universe that is nevertheless highly regulated to face the worst crises, the adoption of this unprecedented and unexpected measure gave the impression that regulators had lost confidence in their own prudential rules. With the central bank having information on which banks the market does not have, investors may have feared the worst. Shouting fire, central bank firefighters fueled a panic, even though the fire did not take place. Long-term negative consequences The consequences of this episode are not neutral for the banking sector. Investors realized that their dividend could be suspended without notice in the event of economic concerns. Fearing the repetition of similar measures during future market ups and downs, they will now tend to increase the discount applied to bank stocks to take this latent risk into account. Far from being a simple question of shareholders’ frustration, the subject hides a more serious problem, that of the cost of capital and its access for credit institutions. The sector’s ability to raise capital in good condition could indeed be reduced. By wanting to protect banks in the short term, the ECB reduced their ability to finance themselves under good conditions. And this, while the banks are already faced with profitability problems linked to low interest rates, changes in banking practices (digitization) and competition from FinTechs, which have led them to announce serial restructuring (closures agencies, downsizing). The results of dividend cuts are therefore very mixed, especially since the retention of capital for the benefit of banks has turned out to be very symbolic. The annual dividends of the European banking sector indeed represent 0.5% to 0.6% of regulatory capital (less than 5% of bank equity). Their elimination would therefore have had only a slight impact on the preservation of bank reserves in the event of a “severe” crisis. A practice to be banned to better manage the next crises The lifting of restrictions now seems to have been achieved by the end of July and credit institutions will soon be able to return to their pre-crisis yields, which are multi-year in some cases. We can indeed expect a significant increase in dividends and share buybacks within the banking sector to compensate for the prolonged absence of shareholder remuneration. This movement should be an important catalyst in the coming months for the entire sector in Europe. But in reality, we must above all hope that this “return to normal” will be accompanied by a reestablishment of regulatory stability. Banking regulation is indeed a question of predictability and proportionality, unlike the suddenness of the announcements of March 2020. The European Parliament is now wondering about the need to legislate on the subject to give a legal framework to this practice. . However, the ECB seems to have realized the pitfalls of this policy, according to a letter of May 18, 2021 sent to two MEPs by Andrea Enria, chairman of the ECB’s supervisory board: “The advantages of a dividend restriction must be carefully weighed against its drawbacks. () Agrave; in the light of this experience, I see no clear and compelling need to endow supervisory authorities with the power to impose general and legally binding restrictions on dividends (). Such a process would run counter to other important legislative initiatives aimed at complementing the architecture of the banking union. “A firm commitment by the ECB to no longer use this practice would be welcome to restore investor confidence in the banking sector in the medium term.