Banks are often in the political and regulatory crosshairs during times of economic stress, and COVID-19 is no different. Support for the payments system and credit markets can look like support for banks themselves. And supports for businesses are controversial. Few people want to prop up firms with no future and nobody wants government credit or transfer payments to fund executive bonuses or flow to shareholders through share buybacks or unsustainable dividends. Canada’s banks have just reported weak second-quarter earnings. Laurentian Bank just cut its dividend. Should the Office of the Superintendent of Financial Institutions (OSFI) ask other Canadian banks to do the same?
If they did, they would be following a trend. The European Central Bank has called on European banks to suspend dividends until fall. Dividends of banks in the United Kingdom are under pressure from the Bank of England. Australia’s prudential regulator has suggested a “prudent reduction in dividends.” U.S. banks cut their dividends during the 2008-9 crisis and some argue they should do it again now — perhaps as a quid pro quo for support from the U.S. Federal Reserve.
Canadian banks might, as Laurentian just did, cut dividends to conserve capital. But that should be their decision as the case for regulatory pressure is weak.To start with the government supports, the Bank of Canada’s injections of liquidity into the financial system and unusual asset purchases to support credit markets generally were motivated by fear that the slump triggered by COVID-19 might trigger a financial crisis. But the slump did not originate with deposit-taking institutions. Banks were more the channels of assistance than the recipients of it.
We are depending on the banks to help Canada’s economy through the crisis. OSFI announced early on that financial institutions could treat mortgage deferrals as performing loans, reducing the amounts of capital they would otherwise have to hold. It also reduced its domestic stability buffer, meaning Canadian banks can hold less high-quality capital for at least 18 months, which created $300 billion in lending room. In good times, the buffer obliges Canadian banks to hold more high-quality capital than systemically important banks elsewhere. The payoff is that in bad times they have more capacity to reduce the buffer, cushion the downturn and accelerate the recovery.
The federal government’s credit support involves partnerships with private-sector lenders. That is partly to give a push to private lending stalled by uncertainty. It also leverages the expertise of financial intermediaries to get the money out and adds a layer of protection against fraud.
Both OSFI’s moves and the federal government’s credit supports in partnership with private lenders will work better if the private lenders are making decisions on the basis of their own assessments of risks and rewards, including the risks and rewards of those decisions for their shareholders.
With the economy as fragile as it is at the moment, it is also worth noting how important dividend flows from banks have become for Canadian investors — both individuals and institutional investors such as pension funds. Earlier this year, the Big Six banks alone paid about 30 per cent of all dividends from companies in the TSX index, a figure that has almost certainly risen in the wake of dividend cuts by energy companies, the next highest category. Nothing can or should protect shareholders in a bank from dividend cuts reflecting a deterioration in its business. But that is not the case here.
While Canadian bank earnings for the quarter ending April 31 were down, that followed an extraordinary run of good performance. Canada’s Big Six banks reported an average return on equity of almost 16 per cent in the previous quarter — well above the figures in other advanced economies, including the United States. We have not yet seen anything to suggest the need for OSFI to oblige the banks to do anything they would not do on their own.
A stable, well-performing banking system has been an asset to Canada in previous periods of economic stress, and we will want private deposit-takers and lenders to be in the forefront as we emerge from the COVID-19 crisis. Happily, our banks are in a position where they can be allowed to make their own decisions about paying out dividends. Canada’s policy-makers have enough to do without worrying about that.
Jeremy Kronick is Associate Director, Research, and William B.P. Robson president and CEO of the C.D. Howe Institute.