Finance: Research, Policy and Anecdotes

Important disclaimer: I am a member of the Advisory Scientific Committee of the ESRB. However, the views expressed below are exclusively mine and do not necessarily reflect the official stance of the ESRB or its member institutions.

The General Board of the ESRB decided to allow the revised recommendation on payout restrictions lapse at the end of this month, maybe not a surprising decision given the earlier decision of the ECB Supervisory Board in July. This brings to an end over 16 months of such ‘restrictions’, given that these were recommendations, the restrictions were soft, though it seems that at least in the banking sector, the compliance was high.  Payout restrictions were controversial from the beginning; as discussed in this ESRB report (which was the basis for the first ESRB recommendation in June 2020) , there are good arguments on either side. Many felt that in spring 2020 the arguments in favour of such restrictions were stronger than the arguments against them: extremely high uncertainty (unknown unknowns) and an unprecedented degree of government support for the economy. The situation has certainly changed; there is a clear exit path from the pandemic; bank and corporate fragility concerns are lower than anticipated just a year ago and fiscal support is being phased out. On the other hand, the stress tests published in July have shown quite some variation across banks in terms of possible fragility and the fallout from the pandemic both in corporate and ultimately banking sector will not become clear until next year, the earliest. But importantly, profit distributions are an important part of the market process; a market-based process of bank restructuring and consolidation cannot take place, if equity holders are deprived of their property rights!

All of these arguments seem to speak clearly in favour of moving away from blanket (macroprudential) restrictions to more targeted (microprudential) approaches, in the context of the usual supervisory process. There will certainly (and hopefully) research being done in the coming years to assess the impact of these restrictions. The final word is certainly not spoken yet.

A related discussion is whether macroprudential authorities should get formal powers to impose such restrictions to distribute profits during crisis times. I am somewhat sceptical on this. Macroprudential tools are designed for the financial cycle; the situation in 2020 was certainly not a financial cycle situation. Prudential authorities have ample tools to intervene into failing banks (the fact that they are not always being used is a topic for a different conversation), formal powers to suspend property rights across the financial sector seems a rather extreme step. There is certainly an important discussion to be had on the use of such a tool outside all but the most extreme economic situations and certain safeguards for the use of such instrument might be needed.

Overview