Jay! EBA clarifies dividend multiples

This is helpful, even with the risk of introducing rules that allow banks to pay minimum, promised, payment amounts.

The European Banking Authority (EBA) launched a consultation Draft Regulatory Technical Standards on bank capital  aimed at setting harmonised criteria for instruments with multiple distributions that would create a disproportionate drag on capital, as well as clarifying the meaning of preferential distributions.

The clarification is important, because bank regulation generally disqualifies capital instruments with preferences, e.g. preferred shares. In particular, securities that secure the payments to the holders should not be included in regulatory capital.

But what if the security pays twice the amount of dividend paid on ordinary shares? Is that a traditional preference, knowing that zero dividend on ordinary shares translates into 2 times zero (=0) paid on the security?

The draft RTS presents two approaches, one for joint stock companies, and one for non-joint stock companies, e.g. cooperatives:

For joint stock (JS) companies, the RTS acknowledges the drag on cash flows caused by non-voting shares;  as investors in non-voting shares require compensation for the absence of voting rights.  EBA proposes to apply limits to these distributions (which are sometimes called “multiples”, because the payment on non-voting shares is a multiple of the dividend paid on voting shares).

The limit for the JS multiple is set to a max of 1.25 of the dividend paid on ordinary shares; that is, as long as the total amount paid on voting and non-voting shares is capped at 1.05 of the dividend amount paid on voting and non-voting shares, assuming non-voting shares had no multiple. This last condition prevents a bank from issuing a disproportionate amount of non-voting shares with a high multiple.

For Non-JS companies, it is more complex. EBA proposes a differentiated approach, based on the specificities of this type of institution. This is why the approach proposed for NJS companies is not based on the setting of quantitative limits, but takes into account other factors such as the fact that the non-voting shares will be held by voting members, that voting shares are in some cases subject to a legal cap or that the level of distributions for NJS companies is in general limited.

Note that caps on payments are controversial. In theory a cap should prevent banks from paying out too much cash to holders of capital securities. From a prudential point of view this may make sense. However, in practice, banks and investors will treat the cap as a floor. Investors will notice the cap and expect a bank to pay the maximum amount. Investors will expect to be paid up to the cap, thus turning the cap into a floor. Once the cap becomes a floor, banks will find it difficult to cut dividend payments; which poses a threat to the safety and stability of banks.

EBA denies that the RTS introduces caps, I think time will tell if that is the case.