Manuel A. Muñoz, 03 July 2020

According to the evidence, banks in the euro area are particularly reluctant to cut back on dividends during economic recessions. That is, the bulk of the adjustment in the face of negative shocks that hit bank profits is borne by undistributed net income. This column argue that this pattern can notably exacerbate the impact of a negative supply shock such as the COVID-19 pandemic on bank lending and economic activity. Using a macro-banking DSGE model calibrated to quarterly data of the euro area economy, it concludes that restricting dividend distributions has the potential to significantly improve the effectiveness of the countercyclical capital buffer release in ensuring that banks keep funding households and firms during the COVID-19 crisis.

CEPR Policy Research