It wasn’t the clearest as the message progressed. The Bank of England announced this week that the disastrous economic consequences of the coronavirus pandemic are waning and lenders can pay dividends immediately. But at the same time, the central bank has protected lenders for at least 18 months in a “response buffer,” an additional cushion of shareholder funds to absorb losses, almost like a rainy day fund. The BoE’s reasoning is understandable, but there is a risk of discrepancy. If a bank is healthy enough to lift its dividend limit, it should be healthy enough to contribute to the buffer.
Like the US Federal Reserve and European Central Bank, the BoE imposed restrictions in 2020 as Covid-19 spreads and governments adopt a militant base. The dividend cap was a contingency measure for emergencies, even if its ultimate use could be discussed given the low loan loss. The BoE was expected to follow as the Fed recently lifted its regulations and the ECB plans similar actions. After all, the dividend payout sends the message that the bank is worth investing in. But while the Fed’s decision could be backed by the plentiful returns so far reported by large US banks, the situation in the UK is rather bleak.
Reading tea leaves is the most difficult thing. The BoE now has a particularly gruesome task as the economic and financial cycles are moving at different rates. Although the global economy is still emerging from recession, asset markets are more than already recovering. The stock and real estate markets have reached new peaks. In the UK, government measures have pushed home prices up the steepest in a decade. The BoE’s Financial Policy Committee noted in its report that asset prices could plummet if market expectations for growth and inflation change. Overall, the UK economic outlook improved compared to the forecast six months ago, mainly due to the effectiveness of the vaccine launch.
Meanwhile, the counter-cyclical buffer, which is currently set at zero, should be raised during what the BoE typically considers an economic uptrend to allow banks to continue lending and absorb losses in more difficult times. Important measures implemented after the financial crisis to protect the economy from banks and banks from the economy.
The reason the BoE has not raised its buffer for at least six months and no raises for one year thereafter is because households and businesses continue to need support, especially as special measures come to a halt during the pandemic. Not having to create buffers is an additional incentive for banks to lend to the real economy. However, the BoE released a stress test on banks’ balance sheets on Tuesday, revealing an “encouraging” picture showing lenders are resilient and able to lend to a far worse outcome than the current BoE central forecast. Arguments in favor of raising the buffer.
Either way, shareholders should not expect a dividend jackpot. The BoE will rely heavily on banks to ensure easing, especially when a coronavirus strain swept the UK and the impact of unprotected loan losses on banks is unclear. That pressure is welcome. However, it would have been better if the bank’s rainy season fund was also replenished.
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