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ECB says European Banks can restart dividend payments in 2021 under strict limits

28 December 2020, 21:58 CET

Top financial regulators from Europe are now working on the finishing touches of recommendations that allow Europe's strongest banks to restart dividend payments starting next year. This ends a nine-month hiatus which has been imposed as a consequence of the crisis caused by the COVID-19 crisis.

The ECB's supervisory board, which oversees 117 of the biggest banks spread across the eurozone, decided to have a meeting in which the conditions for accepting some lenders to restart their dividend payments would have been discussed.

It was expected that ECB was going to impose stricter limits on banks' expected dividend payments for next year than those imposed by the Bank of England, which has rethought its ban on shareholder payments distributions in the sector at the beginning of this month.

Money coin notes - Photo by Dmitry Demidko on Unsplash

Pandemic's arrival in Europe messed everybody's finances

In March, shortly after the COVID-19 pandemic arrived in Europe, ECB ordered banks part of the eurozone to stop all dividends and share payouts to conserve €30bn of capital. For the first time in the decade-long dividend history, banks were asked to pause their payout plans for a time when the pandemic crisis would show some signs of coming to an end. Since then, there have been many pressured made for ECB to allow stronger back from the eurozone to resume payouts early in 2021.

This situation has spilt financial regulators from Europe into two sides. Some have claimed that the banking sector should continue to conserve capital in order to be prepared for a potential surge in defaults that is likely to happen as a consequence of European governments winding down their loan guarantees and other policies to save their economies from the crisis caused by the pandemic.

Yet, others argued that the ban on dividend payouts would only backfire by driving investors away from the sector and reducing the sector's capability of raising fresh capital.

Stricter limits on payouts than expected by banks and investors

While the announcements that ECB may allow eurozone's biggest banks to restart dividend payments in 2021 may have put a smile on investors face and bring a glimmer of hope to the banking sector, bank regulators from Europe have actually decided to set pretty severe limits on payouts to investors in the banking sector.

This looked-for decision to eliminate the de-facto ban on dividend payouts has come at the moment when the region was just entering the second wave of lockdowns. Yet, instead of cheering investors, it somehow only underscored the challenges lenders are going through during this time of crisis.

While lenders have pledged to return large amounts of capital to shareholders, European Central Bank's decision to order banks in Europe to maintain repurchases of dividends and share to less than 15% of profit for last and this year, or 0.2% of their key capital ratio, whatever option is lower. These strict orders make a much more conservative payout level than announced by the Bank of England earlier this month.

As opposed to ECB's payout limits, the Bank of England decided to allow lenders to make sure that the amounts of payouts aren't larger than 0.2% of their risk-weighted assets, or 25% from the cumulative profits of quarters over last and current years, after deducting shareholder payouts.

Once again, this splits financial regulators into two different sides. Some European lenders warn that being unable to return cash to investors will only drive them away from the capital markets. Yet, others believe that despite some optimism that the pandemic is almost over, allowing a full return to payouts can cause banks to remain without the financial reserves to tackle losses without taxpayer bailouts.

It's no surprise that these strict conditions under which lenders can pay dividends to investors are disappointing as some lenders had raised the prospect of higher payouts. The interest rate limit imposed makes ECB one of the most antipathetic watchdogs in Europe. Yet, lenders are hoping to be free to return more money to shareholders in the fourth quarter of 2021.

Impatience to pay investors as soon as possible

As the COVID-19 pandemic was causing even more damage to economies in the eurozone, the banks in the area that were the hardest-hit by the suspension order became more vocal about asking ECB for a return to payouts. For example, Societe General SA Chairman Lorenzo Bini-Smaghi and Banco Santander SA counterpart Ana Botin expressed their concerns that the ban can backfire, leading to more expensive loans and even cutting lenders off from investor funds.

As expected, the two believe that prohibiting banks from giving investors dividends, even small, symbolic ones only scare them away from the banking sector. It discourages new investors from entering the sector and makes experienced investors stop investing. In other words, the prohibition to distribute dividends is making the banking sector look investable.

It's all a vicious circle because if investors no longer put their money in the banking sector, the sector no longer has robust capital and isn't profitable. Consequently, this means that they will be unable to return funds to those shareholders who do have the courage to invest in the sector despite the current prohibition.

On the other hand, this is a sensitive matter because even by allowing banks to pay dividends, that doesn't mean that the sector will get back on the right track. If they do pay dividends and shortly after have to ask for state aid, that's another sign that the sector isn't, in fact, doing so well. Thus, EBC's payout limits do make sense in urging lenders to be considerate with how much they give shareholders back.

The decision to lift the de-facto ban on dividends was also accompanied by recommendations for banks also to be extremely moderate when it comes to providing staff compensation.

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