Double-edged Strengthening of Banks’ Equity

A few days after the European Central Bank and the German Federal Financial Supervisory Authority (BaFin), the European Systemic Risk Board (ESRB) is now recommending that distributions continue to be restrictive in view of the corona pandemic. General Board of the European Systemic Risk Board held its 40th regular meeting on December 15, 2020.

According to the ESRB, banks, investment firms, insurers and reinsurers should not make any distributions until the end of September 2021, unless they are extremely careful and observe the requirements of the responsible supervisory authorities. The ESRB advises them to set conservative thresholds and take into account the specifics of the individual financial sectors.

With its decision, the ESRB is moving away from its previous position of foregoing distributions across the board. One background is the prospect of a Covod-19 vaccine, which makes even more severe scenarios less likely. The General Board recognised the importance of distributions in enabling financial institutions to raise capital externally.

“The decision of the ESRB is a confirmation of our previous supervisory practice”, comments BaFin President Felix Hufeld. This also applies to the latest ECB decision on this issue. “We support the general appeal unreservedly and make binding decisions in individual cases – if necessary.” Only those companies are allowed to pay out that are sufficiently solid and that comply with the minimum legal requirements even under corona stress conditions.

Although the General Board recognised the importance of distributions in enabling financial institutions to raise capital externally, the question arises as to how government intervention in the dividend policy of financial service providers should not strain their ability to raise equity.

Since the reasons for and extent of such political interventions are difficult to predict for both investors and analysts, investments in banks are becoming less attractive. Since all of the above-mentioned organizations are aware of these implications, the question of whether nationalization of banks can be avoided must be investigated.

At first sight, the restriction on distributions strengthens the equity base, banks’ resilience and thus also the creditworthiness of financial institutions. However, rating agencies need to consider both short-term and long-term implications. The corona-related interventions make it difficult for the rating agencies to make their forecasts.

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