Dividends and Lending: EU Banks Wait on Europe

HSBC

Banks in Europe are eagerly awaiting regulators to allow them to pump up their dividends, highlighting the disconnect between the economic necessities of Europe and the reality of lending conditions facing financial firms.

Coping with capital requirements and weak demand throughout the euro zone has stifled lending to non-financial institutions, pushing banks to keep stockpiling cash, and firms including HSBC (NYSE:HBC), UBS (NYSE:UBS), Swedbank, and others are eager to entice shareholders with higher dividend yields. However, regulatory bodies stand in the way, and after the financial crash in 2008, regulators are acting methodically to ensure banks are liquid enough. Financial firms were highly leveraged during the crash — keeping little in the way of equity against risk should some of their investments fail. Dividends can work to deplete a firm’s available cash, and with Swedbank aiming to pay out 75 percent of annual profits, regulators are acting carefully.

For Spanish banks, the story is a bit different as the economy continues to struggle, and unemployment remains stubbornly high. The International Monetary Fund in fact suggested to Spanish banks this month that they cut dividends not only to meet capital requirements, but also to free up cash for lending. But as institutions like Swedbank show, in many cases, it makes more sense for firms to invest in making shareholders happy, rather than investing in their own countries, where policy and the economy remain a much less lucrative allocation of resources.

Particularly in Spain, Prime Minister Mariano Rajoy has taken to a more positive message, encouraging the public that an economic recovery is slated for the third quarter instead of the fourth, a message which should resonate with lenders. However, the reality is not so peachy, as Santiago Sanchez Guiu, economist at the Carlos III University in Madrid, explained to Reuters. “The main problem of the Spanish economy is the massive damage suffered by the labor market and the businesses, which will weigh heavily on any recovery. We can’t rule out a new slump because these factors will weigh so much,” he said.

While Spain only contracted 0.1 percent quarter-on-quarter from April to June, the prospects of a robust turn remain dim, and the impetus for lending along with them. As Deutsche Bank economist Gilles Moec said, stability is not growth. “Recent data flow has shown quite an improvement…consistent with some stabilization in GDP, but not yet consistent with growth. But the Spanish government is still very far from completing its fiscal adjustment, so there will be a ceiling on domestic demand for two or three years.”

The ceiling on demand there could also easily equate to a ceiling on lending from banks, a problematic scenario for Europe. Until economic conditions truly turn the corner, shareholders are likely to remain more lucrative than actual investments in businesses, and this crucial avenue of growth for Europe will remain stagnant.

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