ESRB Evaluates Effectiveness of Dividend-Based Prudential Regulation
ESRB published a working paper that investigates the effectiveness of dividend-based macro-prudential rules in complementing capital requirements to promote bank soundness and sustained lending. Available evidence on euro area bank dividends and earnings suggests there is a potential link between the payout policies and the adjustment mechanisms, through which bankers opt to meet their target regulatory capital ratios. This paper develops a Dynamic Stochastic General Equilibrium (DSGE) model that features a banking sector and certain financial frictions that account for this empirical phenomenon. Then, it defines a dividend-based regulatory scheme that is shown to be an effective macro-prudential complement to capital requirements.
The paper presents empirical evidence on bank dividends and earnings in the euro area. It describes the basic model and identifies the transmission mechanism through which a dividend prudential target improves bank soundness and financial stability. Further it presents the extended model to improve the matching of the model to the data and develops a quantitative exercise to assess the welfare effects of the proposed policy and its interactions with regulatory capital ratios. Welfare-maximizing dividend-based macro-prudential rules are shown to have important properties:
- They are effective in smoothing the financial and the business cycle by means of less volatile bank retained earnings
- They induce welfare gains associated to a Basel III-type of capital regulation
- They mainly operate through their cyclical component, ensuring that long-run dividend payouts remain unaffected
- They are flexible enough so as to allow bank managers to optimally deviate from the target (conditional on the payment of a sanction)
- They are associated to a sanctions regime that acts as an insurance scheme for the real economy
The paper highlights that simplicity of the model is instrumental to clearly identify the transmission mechanism through which the proposed policy rule operates. Yet, it comes at the cost of abstracting from a number of considerations that potentially constitute promising avenues for future research. Modeling one or more of the market imperfections that may be behind bank dividend policies should be helpful to match the data by means of an improved micro foundation of the macro-economic model. Moreover, additional ingredients that are present in reality and that could possibly change some of the results have been omitted. The paper concludes that optimal coordination between this type of prudential regulation and other macroeconomic policies should be considered as well.
Related Link: Working Paper (PDF)
Keywords: Europe, EU, Banking, Securities, DSGE Model, Macro-Prudential Regulation, Capital Requirements, Dividend-Based Rules, Financial Stability, Basel III, ESRB
Featured Experts
María Cañamero
Skilled market researcher; growth strategist; successful go-to-market campaign developer
Nicolas Degruson
Works with financial institutions, regulatory experts, business analysts, product managers, and software engineers to drive regulatory solutions across the globe.
Patrycja Oleksza
Applies proficiency and knowledge to regulatory capital and reporting analysis and coordinates business and product strategies in the banking technology area
Previous Article
SBIF Releases Technical Note on FintechRelated Articles
BIS and Central Banks Experiment with GenAI to Assess Climate Risks
A recent report from the Bank for International Settlements (BIS) Innovation Hub details Project Gaia, a collaboration between the BIS Innovation Hub Eurosystem Center and certain central banks in Europe
Nearly 25% G-SIBs Commit to Adopting TNFD Nature-Related Disclosures
Nature-related risks are increasing in severity and frequency, affecting businesses, capital providers, financial systems, and economies.
Singapore to Mandate Climate Disclosures from FY2025
Singapore recently took a significant step toward turning climate ambition into action, with the introduction of mandatory climate-related disclosures for listed and large non-listed companies
SEC Finalizes Climate-Related Disclosures Rule
The U.S. Securities and Exchange Commission (SEC) has finalized the long-awaited rule that mandates climate-related disclosures for domestic and foreign publicly listed companies in the U.S.
EBA Proposes Standards Related to Standardized Credit Risk Approach
The European Banking Authority (EBA) has been taking significant steps toward implementing the Basel III framework and strengthening the regulatory framework for credit institutions in the EU
US Regulators Release Stress Test Scenarios for Banks
The U.S. regulators recently released baseline and severely adverse scenarios, along with other details, for stress testing the banks in 2024. The relevant U.S. banking regulators are the Federal Reserve Bank (FED), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC).
Asian Governments Aim for Interoperability in AI Governance Frameworks
The regulatory landscape for artificial intelligence (AI), including the generative kind, is evolving rapidly, with governments and regulators aiming to address the challenges and opportunities presented by this transformative technology.
EBA Proposes Operational Risk Standards Under Final Basel III Package
The European Union (EU) has been working on the final elements of Basel III standards, with endorsement of the Banking Package and the publication of the European Banking Authority (EBA) roadmap on Basel III implementation in December 2023.
EFRAG Proposes XBRL Taxonomy and Standard for Listed SMEs Under ESRS
The European Financial Reporting Advisory Group (EFRAG), which plays a crucial role in shaping corporate reporting standards in European Union (EU), is seeking comments, until May 21, 2024, on the Exposure Draft ESRS for listed SMEs.
ECB to Expand Climate Change Work in 2024-2025
Banking regulators worldwide are increasingly focusing on addressing, monitoring, and supervising the institutions' exposure to climate and environmental risks.
