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Rethinking Capital Regulation: The Case for a Dividend Prudential Target

Manuel A. Muñoz

International Journal of Central Banking, 2021, vol. 17, issue 3, 271-336

Abstract: Recent empirical studies have documented two remarkable patterns shown by euro-area banks in the aftermath of the Great Recession: (i) their tendency to boost capital ratios by shrinking assets (contraction in loan supply), and (ii) their reluctance to cut back on dividends (fall in retained earnings). First, I provide evidence of a potential link between these two trends. When shocks hit their profits, banks tend to adjust retained earnings to smooth dividends. This generates bank equity and credit supply volatility. Then I develop a DSGE model that incorporates this mechanism to study the transmission and effects of a novel macroprudential policy rule-that I shall call dividend prudential target (DPT)-aimed at complementing existing capital regulation by tackling this issue. Welfare-maximizing DPTs are effective (more than the CCyB) in smoothing the financial and the business cycle (by means of less volatile retained earnings) and induce significant welfare gains associated with a Basel III type of capital regulation through various channels.

JEL-codes: E44 E61 G21 G28 G35 (search for similar items in EconPapers)
Date: 2021
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Related works:
Working Paper: Rethinking capital regulation: the case for a dividend prudential target (2020) Downloads
Working Paper: Rethinking capital regulation: the case for a dividend prudential target (2019) Downloads
Working Paper: Rethinking Capital Regulation: The Case for a Dividend Prudential Target (2018) Downloads
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