Dividends and Bank Capital in the Financial Crisis of 2007-2009

Abstract:     
The headline numbers appear to show that even as banks and financial intermediaries have suffered large credit losses in the financial crisis of 2007-09, they have raised substantial amounts of new capital, both from private investors and from government-funded capital injections. However, on closer inspection the composition of bank capital has shifted radically from one based on common equity to that based on debt-like hybrid claims such as preferred equity and subordinated debt. The erosion of common equity has been exacerbated by large scale payments of dividends, in spite of widely anticipated credit losses. Dividend payments represent a transfer from creditors (and taxpayers) to equityholders in violation of the priority of debt over equity. The dwindling pool of common equity in the banking system may be one reason for the continued reluctance to lend by banks. We draw conclusions on how capital regulation may be reformed in light of our findings.

Number of Pages in PDF File: 36

Keywords: Credit Crisis, Bank Capital, Dividends

JEL Classification: G21, G28

working papers series