UK banks should use dividend freedom with care

Freedom Day has arrived — if you’re a bank at least.

The government this week sent a message of caution on how enthusiastically the population should be working, socialising and travelling in maskless freedom after the lifting of legal restrictions later this month. The pandemic is not over, was the nub of it, and risks remain even as curbs are lifted.

The UK banking system saw its liberties restricted last March when the Bank of England banned investor payouts to bolster financial stability and preserve their ability to lend in what turned out to be an almighty downturn.

Now even the training wheels — sorry, guardrails — are off, with the lifting of December’s parameters for acceptable payouts that set a cap at 25 per cent of quarterly profits. That follows the relaxing of US restrictions on payouts, with European regulators expected to announce a lifting of bans for later this year. 

But bank boards contemplating their unbridled freedom to set distributions to shareholders should heed the same message delivered to those contemplating a return to the sticky floors of UK nightclubs. Tread carefully.

To its detractors, the dividend ban was an unnecessary and ultimately harmful move. It crystallised the idea that banks are instruments of public policy first, and investments second. 

That not only penalised investors in these quasi-utilities but also cast doubt over the sector’s appeal longer-term. Research from the European Central Bank found a 7 per cent negative impact on bank valuations from the dividend ban, most of which related to greater uncertainty over future payouts rather than simply lower cash flows. That could make it harder, and more costly, for the sector to raise money in the future.

The reality is that it’s only possible to say in retrospect that the ban looked unnecessary. Yes, it preserved a relatively small amount of capital: analysts at Jefferies last year suggested that cancelling final dividends for 2019 saved perhaps 50 basis points on average of common equity tier one capital. The sector’s CET1 ratio rose last year and sits at over 16 per cent.

But the level of losses owed a huge amount to the extraordinary support pumped into the system by the government, much of it via the banks. Markets were pricing in credit impairments of up to £80bn for the UK banks in 2020 and 2021, said the BOE mid-last year. In the event, they took credit losses of about £20bn, and analyst expectations of losses across the two years have fallen from £45bn to £30bn, suggesting a halving (at least) this year.

How that would have looked without the government stepping in to pay 9 million people’s wages, at the peak of the furlough scheme, or backing schemes which contributed the vast majority of the £76bn in net additional financing to UK businesses is anyone’s guess. 

It’s true that the result is a sector with, if anything, a surfeit of capital, even if coming rule changes may whittle away at the excess. The regulator said on Tuesday that the sector’s latest stress test showed it withstanding a further £70bn in near term impairments from another macroeconomic shock.

But those who bristled at the dividend ban as a piece of presentational politics about burden sharing should see that, while nightclub owners are being urged to think of their “social responsibility”, special distributions to long-suffering shareholders should wait — at least until most government support programmes have wound down, the threat of further restrictions has lifted and the economy’s currently-robust recovery is assured for the longer-term.

The industry must hope that blanket bans and infantilising guardrails are indeed as extraordinary as regulators have suggested, a response to an unprecedented situation that fades in the minds of their investors. 

The best way to hold on to your freedom is to use it carefully.

helen.thomas@ft.com
@helentbiz