At the end of March 2020, the Prudential Regulation Authority (PRA) welcomed the decisions of the boards of the large UK banksfootnote [1] to suspend dividends and buybacks on ordinary shares until the end of 2020. At the PRA’s request they also cancelled payments of any outstanding 2019 dividends and restricted cash bonus payments to senior staff.
This exceptional request reflected the unprecedented levels of economic uncertainty facing the global economy at that time due to the onset of the Covid-19 pandemic. The initial global spread of Covid-19 occurred at a moment late in banks’ dividend calendars when dividend distributions they had announced were about to be paid out. Given this timing, the then existing market conditions, the very large and uncertain size of the forthcoming downturn, and the unique role that banks play in supporting the wider economy, the PRA’s request was a necessary precautionary step in order to reduce the possibility of an unsafe depletion of banks’ capital in the face of a risk of unknown dimensions.
The PRA’s assessment of banks’ capacity to distribute for 2020
In July, the PRA announced that in the fourth quarter it would undertake an assessment of large UK banks’ distribution plans for 2020. This assessment would be based on: the current and projected capital positions of the banks; the level of uncertainty on the future path of the economy; market conditions; and capital trajectories prevailing at that time. The PRA has now completed that assessment.
Notwithstanding the impact of the Covid-19 pandemic on the global economy, banks remain well capitalised and are expected to be able to continue to support the real economy through this period of disruption. The Prudential Regulation Committee (PRC) and Financial Policy Committee (FPC) have now carried out two stress tests of banks’ capital positions and have judged that banks are resilient to a wide range of economic outcomes, including economic scenarios that are materially more severe than current central expectations. Based on these assessments, although some headwinds to banks’ capital positions are expected during 2021, the PRA’s assessment is that banks remain well capitalised and able to support the economy.
Set against that, economic uncertainty as a result of the Covid-19 pandemic remains high, economic disruption continues and widespread government economic support is still in place. In addition, considerable uncertainty remains about the new relationship with the EU to which the UK will need to adapt in the coming months.
Weighing those considerations, and consistent with the PRA’s view that distributions are an important and necessary part of the functioning of the banking system, the PRA judges that an extension of the exceptional and precautionary action taken in March is not necessary and that there is scope for banks to recommence some distributions should their boards choose to do so, within an appropriately prudent framework.
Temporary approach to shareholder distributions for 2020
With the removal of the PRA’s request not to make shareholder distributions, it is for bank boards to determine the appropriate level of distributions. Any distributions should be prudent, reflecting the still elevated levels of economic uncertainty and the need for banks to continue to support households and businesses through the continuing economic disruption, even in the event that this disruption is more prolonged and severe than currently anticipated. As a stepping stone back towards its standard approach to capital-setting and shareholder distributions the PRA therefore asks boards, when making their decisions for 2020 distributions, to operate within a framework of temporary guardrails. The PRA is publishing that framework now in order to give bank boards time to take it into account as they approach those decisions in coming months.
In relation to full-year 2020 results, distributions to ordinary shareholders by large UK banks should not exceed the higher of: 20 basis points of risk-weighted assets as at end-2020; or 25% of cumulative eight-quarter profits covering 2019 and 2020 after deducting prior shareholder distributions over that period.footnote [2] The PRA will expect to be satisfied that any distributions would not create excess vulnerabilities to stress for a given bank or impede its ability or willingness to support households and businesses. The PRA has designed the guardrails above in line with its primary objective to promote the safety and soundness of firms we regulate and it is the responsibility of banks’ boards to make distributions which are consistent with this objective. Accordingly if any firm wishes to make shareholder distributions in excess of these guardrails, it should engage with its supervisors and expect a high bar for justifying any exceptions.
The PRA is also updating its expectations on the payment of cash bonuses to senior staff, including all material risk takers, by large UK banks.footnote [3] The PRA expects firms to exercise a high degree of caution and prudence in determining the size of any cash bonuses granted to senior staff given the uncertain outlook and the need for banks to deploy capital to support the wider economy. The PRA will scrutinise proposed pay-outs closely to ensure large banks have applied the PRA’s rigorous remuneration regime in an appropriate fashion.
Returning to standard capital-setting and distributions processes through 2021
The PRA intends to transition back to its standard approach to capital-setting and shareholder distributions through 2021. Under this framework, bank boards are responsible for making distribution decisions subject only to the standard constraints of the regulatory framework, including the regular annual stress test.
Following the cancellation of the annual concurrent stress test in 2020 in order to help lenders focus on meeting the needs of households and businesses during the onset of the Covid-19 pandemic, the PRC and FPC intend to undertake a full system-wide stress test in mid-2021 and to publish bank-by-bank results at end-2021. Further details will be set out in due course. In the meantime, for 2021 dividends the PRA is content for appropriately prudent dividends to be accrued but not paid out and aims to provide a further update ahead of the 2021 half-year results of large UK banks.
Barclays, HSBC, Lloyds Banking Group, NatWest, Santander UK and Standard Chartered.
Profits here are defined as net income attributable to shareholders less AT1 coupons, preference share dividends and non-controlling interests, plus one-off impairments of goodwill and intangible assets. Distributions over that period include 2019 ordinary dividends (minus scrip dividends), 2019 special dividends and any buybacks exercised in the period. The PRA may take into account any items of an exceptional or technical nature whose inclusion or exclusion materially flatters a bank’s 2020 Q4 performance.
The firms listed in footnote 1 and Nationwide Building Society.