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Rethinking capital regulation: the case for a dividend prudential target

Manuel A. Muñoz

No 2433, Working Paper Series from European Central Bank

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 of loans 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 to a Basel III-type of capital regulation through various channels. JEL Classification: E44, E61, G21, G28, G35

Keywords: capital requirements; countercyclical capital buffer (CCyB); dividend restrictions; DSGE models; macroprudential policy (search for similar items in EconPapers)
Date: 2020-07
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge and nep-mac
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Related works:
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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