System-wide dividend restrictions: evidence and theory

Summary

Focus

In March 2020, the ECB's Single Supervisory Mechanism recommended that euro area banks should refrain from distributing dividends for the financial years 2019 and 2020 until October 2020 at the earliest. The aim was to preserve bank capital to continue funding households and firms amid the Covid-19 crisis.

Contribution

This paper assesses the costs and benefits of the ECB system-wide dividend restriction or recommendation, or SWDR, for short. To do so, first, we use micro-level data to provide evidence on the recommendation's effects on bank lending, as well as on paid and expected dividends and stock prices. Then we propose an euro area quantitative DSGE model that accounts for this evidence and also captures the main transmission mechanism and general-equilibrium effects of SWDRs.

Findings

In our empirical analysis we find that, on average, banks which did not distribute dividends increased their lending by 5% more than those which distributed dividends. In our model-based analysis, we obtain the following key results, which are complementary to the empirical evidence. First, the ECB SWDR sustained aggregate bank lending to the real economy.The general equilibrium effect of the ECB SWDR on bank lending captured by the model is larger and more persistent than the one estimated by means of the empirical approach, nonetheless. Second, once the dividend ban is lifted, bank dividends recover more swiftly and tend to compensate for what has not been distributed during the ban period. Third, bank equity values are, if anything, only moderately and temporarily affected by the recommendation. 

Abstract

We provide evidence that the ECB system-wide dividend recommendation (SWDR) of March 2020 contributed to sustain lending, had a negative but moderate and transitory impact on bank stock prices and largely operated as a deferral of dividend payouts rather than as a dividend cut. Then, we develop a quantitative macro-banking DSGE model that accounts for this evidence and captures the key mechanism through which SWDRs operate to study the general equilibrium effects of the ECB SWDR. The measure contributed to sustain aggregate bank lending and mitigate the adverse impact of the COVID-19 shock on economic activity by safeguarding euro area banks' capitalization. Welfare-maximizing SWDRs stabilize the economy regardless of the shock type but they only induce significant welfare gains in response to financial shocks.

JEL classification: E44, E58, E61

Keywords : dividend recommendation, dividend prudential target (DPT), COVID-19, usable capital buffers, welfare