Bank shareholders stand to gain from higher interest rates, says ECB

European Central Bank (ECB) interest rate hikes from July 2022 have contributed positively to the remuneration banks give to their shareholders, through dividend payments or share buybacks.

An article in the ECB’s forthcoming economic bulletin, published on Tuesday, analyses banks’ capital distributions and their implications for monetary policy.

ECB economists believe that the increase in banks’ interest margins following the interest rate hikes “is likely to have contributed positively to banks’ capital distributions so far”.

Banks tend to allocate more capital when they are more profitable, have higher quality assets and more liquidity.

Each additional percentage point of return on equity in the banking sector translates into 2 billion euros of higher payouts, according to ECB figures.

Rising interest rates may have the opposite effect over time.

But at the same time interest rate rises are likely to reduce profitability over time because credit growth will weaken, the risk of credit defaults will increase and interest rates on deposits will rise, limiting the room for remuneration.

Since July last year, the ECB has increased its interest rates by 450 basis points to 4.5 % and the deposit facility to 4 %.

In addition, it withdraws very cheap liquidity that it lent to banks and stops reinvesting the bonds it acquired since 2014 when they mature.

The ECB recommended banks not to pay out dividends or buy back shares during the pandemic, but since September 2021 it has stopped making this recommendation and banks have resumed shareholder remuneration.

Shareholder payout volumes exceed those of the pre-pandemic years, but are lower than had been forecast for 2020 and 2021.

Share buyback, the star of shareholder remuneration

The bulk of shareholder remuneration is in the form of share buybacks, which accounted for 33% of shareholder remuneration on 2021 earnings and 29% of expected shareholder remuneration on 2022 earnings.

A representative sample of euro area banks has paid or will pay approximately 50% of their total 2022 profits in dividends or share buybacks, up from an aggregate 44% between 2017 and 2018, the last two years that were not affected by the pandemic.

However, despite the increase in dividends compared to the pre-pandemic period, “many banks are still below their targets or not distributing dividends at all”, according to the ECB.