The coronavirus-induced economic crisis has been a chance for the US banking sector to prove its more steadfast qualities. Post-financial crisis reforms appear to have largely worked. Financial institutions have stood strong, fortified by hundreds of billions in equity capital raised and retained. That is good for depositors and the broader financial system.
For shareholders, however, increased caution curbs payouts. The big six US banks have already suspended share buybacks to preserve capital this year. The Federal Reserve, as a part of stress test results on Thursday, told 33 banks reviewed that they are not permitted to conduct buybacks, cannot grow existing dividends and can only pay out sums that reflect levels of recent profitability. The suggestion that all payouts be banned until the depth of recession is understood, lest banks leave too little loss absorption capacity, is overblown. The Fed’s compromise is the right one. Dividends are meagre relative to equity bases and almost certainly will not be the difference between solvency and peril.
The Fed has run coronavirus-based economic scenarios including economic recoveries shaped like a V, a U and W. In the worst-case scenario, the average loan-loss ratio soared to 10 per cent, indicating $700bn in total losses. Still, the lowest quartile bank did not breach the minimum common equity tier 1 ratio of 4.5 per cent.
For the big six US banks, dividends accounted for around 4 per cent of common shareholder equity bases last year. Buybacks, on the other hand, were twice that. Banks have hesitated to cut dividends mostly because not making the payout would offend shareholders, particularly income sensitive ones.
Unlike 12 years ago, the likes of Citigroup and Bank of America do not have to go begging to investors for preferred stock capital infusions. This is progress. But banks still have common shareholders. The harshest regulatory scolds must understand that the sector still has to attract those types of investors, just in case it needs to raise money from them again.
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