European banks are rewarding their shareholders with record dividend payouts despite the economic slowdown and regulatory pressure to maintain high capital buffers.
According to the European Banking Authority (EBA), the average dividend payout ratio of EU banks rose to 46.4% in 2023, the highest level since the EBA started collecting data in 2014. This means that EU banks distributed almost half of their net income to shareholders, leaving less room for capital accumulation.
Why are EU banks paying more dividends?
One of the main reasons behind the surge in dividend payouts is the improved profitability of EU banks. The EBA reported that the average return on equity (ROE) of EU banks increased to 8.2% in 2023, up from 6.8% in 2022 and 3.1% in 2021. The ROE measures how efficiently banks use their equity to generate profits.
The EBA attributed the rise in profitability to several factors, such as:
- The recovery of the European economy from the COVID-19 pandemic, which boosted lending activity and reduced loan loss provisions.
- The cost-cutting measures implemented by many banks, which reduced their operating expenses and improved their efficiency ratios.
- The diversification of income sources, especially from fee and commission income, which increased the resilience of banks to low interest rates.
Another reason for the higher dividend payouts is the competitive pressure from other sectors and regions. EU banks face stiff competition from US and Asian banks, which tend to pay higher dividends and offer higher returns to investors. EU banks also compete with other industries, such as technology and healthcare, which have higher growth prospects and valuations.
By paying more dividends, EU banks aim to attract and retain investors, increase their share prices, and signal their confidence in their future earnings.
What are the risks and challenges of high dividend payouts?
While high dividend payouts may benefit shareholders in the short term, they also pose some risks and challenges for EU banks in the long term.
One of the main risks is the erosion of capital buffers, which are essential for absorbing losses and supporting growth. The EBA warned that the high dividend payout ratio of EU banks reduced their average common equity tier 1 (CET1) ratio, which measures the quality and quantity of capital, by 0.4 percentage points in 2023. The CET1 ratio of EU banks declined to 15.1% in 2023, down from 15.5% in 2022 and 15.7% in 2021.
The EBA noted that the decline in capital ratios was more pronounced for some banks, especially those with low profitability and high leverage. The EBA urged these banks to adopt a more prudent dividend policy and to align their payouts with their risk profile and capital position.
Another risk is the uncertainty of the economic and regulatory environment, which may require EU banks to hold more capital in the future. The EBA highlighted some of the potential challenges that EU banks may face, such as:
- The impact of the COVID-19 variants and the effectiveness of the vaccination campaigns, which may affect the pace and sustainability of the economic recovery.
- The inflationary pressures and the monetary policy responses, which may affect the interest rate margins and the asset quality of banks.
- The implementation of the Basel III reforms, which may increase the capital requirements and the operational complexity of banks.
- The transition to a low-carbon economy, which may entail significant investments and adjustments for banks.
The EBA advised EU banks to consider these challenges and to maintain adequate capital buffers to cope with them.
How are EU regulators reacting to the high dividend payouts?
EU regulators have adopted a cautious and flexible approach to the dividend policy of EU banks, balancing the interests of shareholders and the stability of the banking system.
In December 2021, the European Central Bank (ECB), which supervises the largest and most systemic EU banks, lifted the cap on dividend payouts that it had imposed since March 2020 due to the COVID-19 crisis. The ECB allowed banks to resume their normal dividend policy, subject to two conditions:
- The bank’s capital ratio must exceed the Pillar 2 requirement (P2R), which is the additional capital that the ECB requires each bank to hold based on its specific risks.
- The bank’s dividend payout ratio must not exceed 50% of its cumulative net income for 2020 and 2021.
The ECB also encouraged banks to use other forms of capital distribution, such as share buybacks, which are more flexible and reversible than dividends.
In January 2022, the European Systemic Risk Board (ESRB), which monitors the systemic risks in the EU financial system, issued a recommendation to the national authorities that oversee the smaller and less systemic EU banks. The ESRB recommended that these authorities adopt a similar approach to the ECB, allowing banks to pay dividends as long as they meet their capital requirements and limit their payout ratio to 50%.
The ESRB also recommended that the national authorities monitor the dividend policy of banks and intervene if necessary to ensure the soundness and resilience of the banking system.
How are EU banks and shareholders reacting to the regulatory guidance?
EU banks and shareholders have welcomed the regulatory guidance, which has provided more clarity and certainty for their dividend policy.
According to a survey by PwC, 80% of the EU banks that are supervised by the ECB plan to resume or increase their dividend payouts in 2023, while 20% plan to maintain or reduce them. The survey also found that 60% of the EU banks plan to use share buybacks as a complementary or alternative tool for capital distribution.
According to a report by Bloomberg, the share prices of EU banks have increased by 25% in 2023, outperforming the broader European stock market, which has increased by 15%. The report also noted that the dividend yields of EU banks, which measure the ratio of dividends to share prices, have reached 4.5%, the highest level since 2016.
The report attributed the strong performance of EU bank stocks to the improved profitability, the higher dividend payouts, and the positive market sentiment.
