The ship has been steadied but when’s the right time to unfurl the sails?

The European Central Bank has done everything it can to maintain the stability of the continent’s finance system during the Covid crisis. In June it doled out 1.3 trillion euros ($1.54 trillion) of super-cheap loans to the banking system at a negative 1% rate; it has also allowed a large-scale moratorium on bad loans and relaxed its rulebook for lenders. Banks aren’t failing or even wobbling. Bond yields in the sector are pretty much where they were before the pandemic struck.

In return for all this largess, banks have had to accept a freeze on shareholder payouts and bonuses. That’s fair enough. Imagine the justified outcry if taxpayer-supported banks were handing cash to their shareholders while millions of Europeans were losing their jobs. The dividend ban also helps ensure that lenders have enough capital to weather loan losses, and it improves their creditworthiness.

But there are unwelcome effects of this freeze. Even though the ECB has avoided calamity, the share prices of the continent’s lenders are stuck near record lows, down 40% on average this year alone. Only part of this is down to the absence of investors payout, but it won’t be helping.

Some will argue that Europe’s banks — struggling to find a sustained way of growing profit at a time of non-existent interest rates — are being valued fairly by shareholders. But there are consequences in this disconnection between how the lenders are being priced by bond investors (very well because of the gush of ECB cash) and by equity investors. Unless the second wave of the pandemic causes a fresh emergency in Europe’s economy, ECB Governor Christine Lagarde should be thinking of how to relax this brake on valuations.

It’s an unhealthy anomaly that credit spreads (the difference between a bank’s bond yields and those of its benchmark) are so tight when bank market capitalizations are this low. We need to start looking for a better balance between suppressing bond yields and not hobbling share prices, especially if banks ever need to raise equity capital.  

Maybe it’s time to allow some animal spirits back. A functioning banking system is reflected in its market capitalization as much as in credit spreads. Not extending the ECB’s outright ban on bank dividends — imposed for the rest of 2020 — may be one solution. It might also encourage much-needed industry consolidation, as higher valuations would make it easier for stronger banks to become acquirers.

In exchange, the central bank and its regulators could start easing back on some of the help they’ve been giving the lenders. Bank credit spreads have narrowed dramatically from their widest point in mid-March, showing the ECB’s liquidity and bond-buying measures have worked perhaps a little too well. 

Emergency measures shouldn’t be allowed to filter down into shareholders’ pockets, and neither should there be a sudden regulatory free-for-all, but there are ways to lift restrictions gradually. A cap on investor payouts might be better than a total ban, and you could limit them to banks with manageable bad-loan provisions.

Many lenders will choose not to pay a dividend for 2020 anyway, and possibly subsequent years. But for those that can there should be some differentiation between the healthy and the sick, otherwise the European banking system will become increasingly zombified.

Lifting bonus restrictions is obviously a much more sensitive topic, and caution there is understandable. Investment bankers had a very strong second quarter, but much of that was down to pandemic-induced market volatility.

The dividend restriction is far from being the chief reason for the endemic underperformance of European bank shares. But it certainly discourages investors looking for alternative sources of steady income at a time of super-low bond yields. It might be time for a gentle readjustment of the tiller.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

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