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Rethinking Capital Regulation: The Case for a Dividend Prudential Target

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  • Manuel A. Muñoz

    (European Central Bank)

Abstract

Recent empirical studies have documented two remarkable patterns shown by euro-area banks in the aftermath of the Great Recession: (i) their tendency to boost capital ratios by shrinking assets (contraction in loan supply), and (ii) their reluctance to cut back on dividends (fall in retained earnings). First, I provide evidence of a potential link between these two trends. When shocks hit their profits, banks tend to adjust retained earnings to smooth dividends. This generates bank equity and credit supply volatility. Then I develop a DSGE model that incorporates this mechanism to study the transmission and effects of a novel macroprudential policy rule-that I shall call dividend prudential target (DPT)-aimed at complementing existing capital regulation by tackling this issue. Welfare-maximizing DPTs are effective (more than the CCyB) in smoothing the financial and the business cycle (by means of less volatile retained earnings) and induce significant welfare gains associated with a Basel III type of capital regulation through various channels.

Suggested Citation

  • Manuel A. Muñoz, 2021. "Rethinking Capital Regulation: The Case for a Dividend Prudential Target," International Journal of Central Banking, International Journal of Central Banking, vol. 17(3), pages 271-336, September.
    • Handle: RePEc:ijc:ijcjou:y:2021:q:3:a:7
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    1. Rethinking capital regulation: the case for a dividend prudential target
      by Christian Zimmermann in NEP-DGE blog on 2019-08-16 03:24:39

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    1. Muñoz, Manuel A., 2020. "Macroprudential policy and the role of institutional investors in housing markets," Working Paper Series 2454, European Central Bank.

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    More about this item

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy

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