Dividends should be subject to macro-pru limits – ECB paper

Policy-makers should impose counter-cyclical limits on how much banks can pay out to shareholders, a working paper published by the European Central Bank argues.

In Rethinking capital regulation: the case for a dividend prudential target, Manuel Muñoz looks at recent data on eurozone banks. He finds that since the global financial crisis, eurozone banks have tended to boost capital ratios by reducing their supply of loans. Over the same period, they have also shown reluctance to cut back on the dividends they pay to shareholders, he says.

These two trends are connected, Muñoz argues. When economic shocks hit the profits of banks, he says, they tend to adjust the level of their retained earnings in order to smooth dividends. This process causes a harmful degree of volatility in both the supply of loans and in banks’ equity levels.

Muñoz examines whether policy-makers capping equity payments would reduce this problem. He uses a uses a dynamic general stochastic equilibrium model to simulate the effects of imposing a countercyclical target on bank dividend payments.

The policy gives bank managers an incentive to tolerate greater fluctuations in dividend payments, he finds. It complements existing macro-prudential measures in smoothing the financial and business cycle, and creates significant welfare gains, Muñoz says.