Coordinating Bank Dividend and Capital Regulation

In this paper, we examine how dividend taxes (and bans) and capital requirements that vary with the state of the economy influence a bank’s optimal capital buffers and shareholder value. In the model, the bank distributes dividends and issues costly equity to maximise shareholder value, while its assets generate stochastic income under time varying macroeconomic conditions. We solve the bank’s stochastic control problem and derive the distribution of its capital buffers in closed form. Imposing dividend taxes (or bans) in bad macroeconomic states generates an intertemporal trade-off, as it encourages capital buffers accumulation in those states but promotes dividend payouts in the good ones. Furthermore, the policy undermines financial stability by reducing the bank’s value and weakening its incentives to recapitalise in both good and bad states. Coordinating dividend taxes with counter-cyclical capital requirements can mitigate value losses and ease the trade-off, but it also exacerbates disincentives for recapitalisation.