Dividend policy and valuation of European banks

The European Central Bank (ECB) in its Financial Stability Review of May 25, performs an analysis on the impact of dividend policy on global banks, specifically after its recommendation of March 27, 2020 to suspend dividend pay-outs and share buybacks until October 1, 2020.

The main conclusions of this analysis carried out by Sándor Gardó, Maciej Grodzicki and Jonas Wendelborn would be the following:

1. The most profitable banks tend to make higher dividend payments as a percentage of their profits (higher pay-out ratios).
2. Banks that reward their shareholders more generously, tend to be valued more highly by the market in terms of the “Price/Book Value” ratio. Euro area banks seem to have been paying structurally lower and more volatile dividends than their competitors in other regions (i.e United States or Nordic countries) which may have further contributed to their persistent low market valuations in relative terms.
   In this regard the analysis remarks that since the guidance was announced, most European banks would have followed the ECB's recommendation, while most of US and Swiss banks have indicated that they would adhered to their pre-Covid-19 dividend plans.
3. The suspension of the dividend payment complying with the recommendation of the ECB has a positive impact on the strengthening of the capital levels of Eurozone banks (around +1.8%), which would be important to face potential losses and to provide lending to the economy, but it would have a negative impact on the cost of equity of the banks driven by prospects of receiving no dividends”