Andrea Enria and Sam Woods were right in preventing banks from paying dividends in March. When the pandemic hit, the top supervisors at the European Central Bank and the Bank of England, respectively, instead kept equity on lenders’ balance sheets. That policy is out of date.
Rapid action by regulators prevented large euro zone lenders from paying out about € 30 billion to shareholders based on 2019 earnings, according to our calculations. Emergency measures were necessary as national lockdowns deprived businesses of cash, while credit markets collapsed. Supervisors were also concerned that rampant credit losses could blow a hole in banks’ capital buffers.
Seven months later, these fears have faded. The initial increase in demand for bank credit was fleeting. Bond markets were quickly reopened for large companies, supported by generous monetary easing from central banks. Non-financial companies in the euro zone issued 119 billion euros of debt securities in April, according to ECB data, about double the monthly average of the previous year. UK capital markets were equally buoyant.
Banks’ profits and capital also held up better than feared. NatWest, for example, on Friday reported a strong Common Equity Tier 1 (CET1) ratio of 18.2%, despite the state-controlled UK lender taking hefty provisions for bad debt this year. That trend should continue.
Members of the Euro Stoxx Banks Index and the five largest British lenders will collectively generate twice the profit before provisioning in 2020 and 2021 than they will set aside for NPL, according to Refinitiv’s median estimates. In other words, bad debts would have to be twice as bad as expected before banks turn to capital.
Therefore, Enria and Woods can afford to drop their blanket dividend ban. However, they still have to put some conditions. One precaution would be to restrict payments to lenders whose CET1 ratio is less than 2 percentage points above the regulatory minimum. That’s a rule of thumb that most bank CEOs follow informally anyway.
The other safeguard is to require dividend-paying banks to keep growing their loan books, ensuring that the rewards to shareholders do not come at the expense of a credit crisis.
The crisis restrictions were crude but necessary, but banks and their clients are in better shape now. Time for a more nuanced approach.