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Rethinking Capital Regulation: The Case for a Dividend Prudential Target in the Euro Area

Author(s): Manuel Muñoz

Date published: Jul 2019

SUERF Policy Note, Issue No 82
by Manuel Muñoz, Spanish Ministry for Economy and Business

 

JEL-codes: E44, E61, G21, G28, G35.
Keywords: Macroprudential regulation, capital requirements, dividend prudential target, financial stability, bank dividends.

 

According to the evidence, euro area banks have a strong preference for smoothing dividends over the cycle. This implies the bulk of the adjustment to shocks that hit bank profits is borne by retained earnings, thereby generating bank equity and, arguably, credit supply volatility. Based on several recent empirical studies, this policy note warns about the potential link between the dividend policies of euro area banks and the adjustment mechanisms through which they improved their capital ratios in the aftermath of the Great Recession. Then, a DSGE modeling approach is adopted to assess the effectiveness of dividend-based macroprudential rules in complementing capital requirements to promote bank soundness and sustained lending over the cycle. What I shall call “dividend prudential targets” seem to induce significant welfare gains associated to a Basel III-type of capital regulation through their smoothing effects on retained earnings and credit supply.

 

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SUERF Policy Note, Issue No 82SUERF Policy Note, Issue No 82

Rethinking Capital Regulation: The Case for a Dividend Prudential Target in the Euro AreaWeb version: Rethinking Capital Regulation: The Case for a Dividend Prudential Target in the Euro Area

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