Low price-to-book ratios and bank dividend payout policies

Summary

Focus

When bank stock prices are low, relative to book value, banks have a stronger incentive to pay out dividends. But paying dividends reduces banks' capacity to lend and weakens their resilience to shocks. In response to the Covid-19 crisis, regulators and banking federations have set or recommended rules that banks should stop their dividend payouts or share buybacks in order to conserve their capital.

Contribution

This paper asks what factors underlie a bank's decision to pay out a dividend. In particular, we look at the relationship between a bank's price-to-book ratio and the likelihood that it will pay a dividend. We study a large group of advanced economy banks, using a sample that runs from the Great Financial Crisis up to the present Covid-19 crisis.

Findings

We find that a bank's propensity to pay dividends depends on its price-to-book ratio, albeit in a non-linear way. The lower the price-to-book ratio, the greater is a bank's propensity to pay dividends. And this negative relationship steepens when the price-to-book ratio falls below 0.7, a result that is robust to several checks. We also show that a bank's propensity to pay a dividend correlates positively with its size and short-run profitability, but not with annual changes in its total assets.

In a hypothetical exercise with fixed balance sheet ratios, we find that if the banks in our sample had completely stopped paying out dividends during the Covid-19 pandemic in 2020, they would have boosted their lending capacity by an additional $0.8–1.1 trillion, depending on the stress scenario. This is equivalent to 1.1–1.6% of total GDP.

Abstract

Banks with a low price-to-book ratio have a greater propensity to pay out dividends. This propensity is especially marked for banks with a price-to-book ratio below a threshold of 0.7. As a sector, banks also tend to have higher dividend payout ratios than non-financial firms. We demonstrate these features using data for 271 advanced economy banks in 30 jurisdictions. Dividend payouts as a proportion of profits rise in a non-linear way as the price-to-book ratio falls below 0.7. In a hypothetical exercise with fixed balance sheet ratios, we find that a complete suspension of bank dividends in 2020 during the Covid-19 pandemic would have added, under different stress scenario, an additional US$ 0.8–1.1 trillion of bank lending capacity in our sample, equivalent to 1.1–1.6% of total GDP.

JEL Codes: G21, G35.

Keywords: dividend payout policy, banks, low interest rates, Covid-19 crisis.