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
Previous ArticleCBIRC Notice on Insurance Fund Investment in Collective Trust Funds
FCA is consulting on its approach to the authorization and supervision of international firms operating in UK.
MAS published amendments to Notice 637 on the risk-based capital adequacy requirements for reporting banks incorporated in Singapore.
FCA announced that it will move firms to RegData from Gabriel in the coming months in stages, based on the reporting requirements of firms.
APRA has concluded its review of the comprehensive plans of authorized deposit-taking institutions for the assessment and management of loans with repayment deferrals.
ESAs (EBA, EIOPA, and ESMA) published the first joint report that assesses risks in the financial sector since the outbreak of the COVID-19 pandemic.
BoE and HM Treasury confirmed that the COVID Corporate Financing Facility (CCFF) will close for new purchases of commercial paper, with effect from March 23, 2021.
ESAs launched a survey seeking feedback on the presentational aspects of product templates under the Sustainable Finance Disclosure Regulation (SFDR or Regulation 2019/2088).
ECB published input of the European System of Central Banks (ESCB) into the EBA feasibility report on reducing the reporting burden for banks in EU.
EC adopted a decision determining, for a limited period of time, that the regulatory framework applicable to central counterparties, or CCPs, in the UK and Northern Ireland is equivalent to the requirements laid down in the European Market Infrastructure Regulation (EMIR or Regulation 648/2012).
EBA has decided to phase out the guidelines on legislative and non-legislative moratoria of loan repayments, in accordance with the earlier specified end of September deadline.