As messages go, it was not the clearest. The Bank of England pronounced this week that the calamitous economic consequences of the coronavirus pandemic were abating and that lenders could once again pay out dividends, with immediate effect. But at the same time, the central bank spared those lenders from the “countercyclical buffer” — an extra cushion of shareholders’ money to absorb losses, almost like a rainy-day fund — in practice for at least another 18 months. The BoE’s reasoning is understandable but risks inconsistency. If banks are healthy enough to have restrictions on dividends lifted, they should be healthy enough to contribute to the buffer.
The BoE, like the US Federal Reserve and the European Central Bank, imposed restrictions in 2020 as Covid-19 took hold and a warlike footing was adopted by governments: encouraging the build-up of capital cushions was indubitably correct. Dividend limits were an emergency measure for extraordinary times, even if their ultimate use can be debated with the benefit of hindsight, given low loan losses. With the Fed recently lifting its own restrictions, and the ECB planning a similar step, it was expected that the BoE would follow suit. After all, paying dividends sends a message that banks are worth investing in. But while the Fed’s decision may be vindicated by the bumper earnings reported so far by the big US banks, the UK picture is somewhat murkier.
Reading the tea leaves is a difficult job at the best of times. The BoE now has a particularly invidious task because the economic and financial cycles are progressing at different paces. While the global economy is still emerging from recession, asset markets have already more than recovered. Stock and real estate markets have hit new peaks. In the UK, government measures have prompted the steepest rise in house prices in a decade. In its report, the BoE’s Financial Policy Committee noted that a shift in the market’s expectations for growth and inflation could lead to asset prices plunging. Overall, it viewed that the UK economy outlook had improved relative to forecasts six months ago, largely due to the efficacy of the vaccines rollout.
Meanwhile, the countercyclical buffer, currently set at zero, ought normally to be raised during what the BoE deems to be an upward economic curve so banks can use it to continue lending and absorb losses during more straitened times. An important measure put in place following the financial crisis, it both protects the economy from the banks and the banks from the economy.
The BoE’s rationale for not raising the buffer for at least another six months — and any increase will not take effect for a year thereafter — was that households and businesses would continue to need support, particularly as extraordinary pandemic-era measures were wound down. Not having to build up the buffer is extra encouragement for banks to lend to the real economy. But the BoE also published stress tests of banks’ balance sheets on Tuesday, revealing an “encouraging” picture that showed lenders resilient to, and able to lend through, outcomes far worse than the current BoE central forecast. That argues in favour of raising the buffer.
Either way, shareholders should not expect a dividend bonanza. The BoE will be leaning heavily on banks to ensure there is moderation, particularly when a coronavirus variant is sweeping through the UK, and the impact on banks of loan losses unprotected by economic stimulus remains unclear. That pressure is welcome. But replenishing banks’ rainy-day fund as well would have been better.