US banks’ dividend payments would hammer firms’ capital, loans, over course of pandemic, Fed researchers say

05 October 2020 16:54 by Neil Roland

US currency

US banks’ dividend payments would significantly cut into firms’ capital and lending ability over the life of the pandemic, Federal Reserve researchers said, even as Fed policymakers are letting capped dividend amounts be paid through year-end.

“The impact of dividend payments is striking,” Federal Reserve Bank of New York researchers said in a study released today. “Covid-19 more severely stresses the banking sector if dividends payments continue.”

Conversely, banks that stop paying dividends “are less prone to meaningfully reduce their capital buffers and thus have more room to increase lending,” said the study by six researchers, including NY Fed research chief Beverly Hirtle.

Nearly all large banks have continued dividend payments during the pandemic, the study said.

— Capital erosion —

Dividend payments erode banks’ capital by 34 percent below regulatory requirements, the study said, using a scenario in which economic activity plunges and recovers slowly over the next three years.

That’s more than double the amount of 16 percent when banks stop paying dividends under the same economic scenario.

Dividend payments reduce capital on a dollar-for-dollar basis.

Banks’ capital requirements consist of a minimum threshold and a buffer that’s largest for the biggest, most complex institutions.

In March, the Fed encouraged banks to let their capital ratios drop below the required buffer to enable additional lending and stimulate the economy.

The study looked at how much dividend payments depleted bank buffers under two alternatives: if firms kept dividends at their fourth quarter of 2019 levels; and if they stopped all dividend payments starting in the first quarter of 2020.

— Dividend payments allowed —

The Republican-controlled Fed, led by Chairman Jerome Powell, has allowed banks to continue to pay dividends for the third and fourth quarters. These payments are capped at the average of banks’ net income over the four previous quarters.

The central bank, referring to the dividend caps and a suspension of share repurchases, said Sept. 30 it is seeking to preserve capital in light of “continued economic uncertainty from the coronavirus response.”

In allowing dividend payments to be continued through year-end, the Fed said that “capital positions of large banks have remained strong during the third quarter while such restrictions were in place.”

A dissenting vote was cast by the sole Democrat on the five-member Fed board, Lael Brainard, who has objected to dividend payments being allowed.

The Fed will conduct the second of two stress tests later this year and release results by year-end.

Former Fed governor Daniel Tarullo, the architect of the stress tests and other regulations after the 2008 financial crisis, has noted that the Fed test used to measure the impact of policy changes on banks’ capital relied on February data.

That data preceded the pandemic in the US and the economy’s plunge.

“A stale scenario is used to allow banks to continue paying dividends,” he said in June.

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