Dividend restrictions for European banks: is the end in sight?

By Daniel Trinder, Senior Policy Advisor, Afore Consulting

The ECB announced on 27th March that banks under its supervision, Single Supervisory Mechanism (SSM) banks, would not be permitted to pay dividends or share buy-backs. This was extended from July until the end of 2020. This week the ECB will make an announcement on the dividend payments for these banks to be paid out after 1 January 2021.

Pressure continues to grow from both banks and investors to relax the restrictions. While canceling dividends keeps extra capital in ECB supervised banks, it significantly reduces their market capitalisation and hinders the ability of banks to raise fresh capital in the future.

Will the position of other regulators influence the ECB’s decision? 

The ECB will do what it believes is right for SSM banks. It is highly possible they will coordinate a decision with EU non-Eurozone supervisors, such as Finansinspektionen in Sweden. Possibly there might also be broader coordination on the timing of announcements across the Basel Committee for Banking Supervisors (BCBS) which would demonstrate some global coordination, although responses will vary. This would also give more political cover to some supervisors rather than decisions seen as purely unilateral.

On the substance of what is announced, the ECB will not be concerned with consistency with BCBS Members, such as Australia, Canada, and the US, all of whom have all permitted bank shareholders to receive dividends and buybacks this year. However, they are likely to have an eye on the Prudential Regulation Authority (PRA) who have also said a decision would be taken on the resume of dividends by the end of the year. That decision is likely to be announced on the 11th of December when the Bank of England releases its latest Financial Stability Report and also the minutes of the Financial Policy Committee (FPC).

 When is the ECB likely to take this decision?

The ECB Governing Council will decide when it meets on 10th December. That same day, the ECB will release its latest macroeconomic projections. This points to a decision being taken then, although the timing could depend on whether there is broader coordination of announcements.

The ECB could decide to delay the decision. Most Eurozone banks do not pay annual dividends out until April/May each year allowing the ECB more time to assess the situation. They could also postpone any decision until after the results of the next EBA stress test in July 2021. However, EBA stress tests have been plagued with concerns over the years, and waiting further would run counter to the ECB’s message that dividend prohibition was temporary and exceptional.

What criteria will the ECB use to decide whether dividends can resume?

In July the ECB stated that they would look at three criteria in determining whether to lift or extend its recommendation on dividends: the macroeconomic outlook, stability of the financial system, and eligibility of banks’ capital planning.

(i)            Macroeconomic outlook

If the adverse scenario under the ECB’s vulnerability assessment exercise in July has become more unlikely overtime, then that will give the ECB confidence in the banks’ ability to pay dividends.

(ii)           Stability of the financial system

Banks’ reported solvency ratios for the last two quarters have been stronger than expected. The increased CET1 ratios, therefore, suggest improvements in financial stability. Another measure of stability is the level of Non-Performing Loans (NPLs). Clearly, NPLs will rise going forward, but the latest reported NPL numbers by the ECB for Q2 showed a decline to just 2.94% of loans. There is also uncertainty over asset quality caused by moratoria and public guarantees. However, a recent EBA report showed that moratoria NPLs were only 2.5% of all loans and that banks were being relatively pro-active in classifying some loans as Stage 2 loans.

(iii)          Banks’ capital planning

The ECB will use the results of its July vulnerability assessment exercise as a key tool with which to challenge banks’ capital plans. The results were not published on a bank-by-bank basis and the ECB stated that it will not even share the detailed results with the banks themselves.

Where are we likely to end up?

The ECB will likely conclude the criteria for the macroeconomic outlook and stability of the financial system have been met. They will not announce a blanket resumption of dividends and/or buy-backs as eligibility of banks' capital planning will need to be decided on a case-by-case basis. ECB supervisors will need to be sufficiently confident that the capital projections put forward are reliable and banks have sufficient capital over the medium-term if they resume dividend payments.

The ECB may also link eligibility to provisioning and/or NPLs. Many EU banks' disclosures of asset quality metrics for Q3 2020 were less detailed than Q2, which appears counterintuitive. About half of EU banks also reported an increase in NPLs (Stage 3 Assets) over the last quarter, whereas about half reported a decline. Linking the resumption of dividends to provisioning/NPLs may avoid problems of the past and nudge them towards a path of longer-term profitability and consolidation which the ECB has been advocating. It may also depend on whether the ECB feels that the NPL Action Plan that the European Commission will announce next week will amount to anything tangible.