Capital Adequacy and Dividend Policy: Evidence from Italian Banks

The Italian banking system was privatised in the early nineties for the purpose of favouring an improvement in capital adequacy in the wake of the deregulation which had occurred between the end of the eighties and early nineties and the simultaneous introduction of prudential supervision. Privatisations often occurred, usually via a larger portion of the bank’s capital being floated on the stock market, also because, in theory, it should be easier for listed banks to raise new capital and therefore pursue and maintain higher capital ratios. In actual fact, twenty years later, large listed Italian banks present lower capital ratios than smaller unlisted banks (Draghi, 2007: 18, 2008: 8; Bank of Italy, 2009: 215, 216, 2010: 220) and large Italian banks have lower capital ratios but better capital quality and lower leverage than their European comparables (Coletti, 2009: 146, Draghi 2009: 15). It would therefore seem that market discipline and global competition in the capital market lead listed banks to optmise capital adequacy and to interpret minimum capital requirements as the maximum level of capital to be maintained. The objective of the paper is to analyse capital adequacy, dividend policy and new share issues of Italian banks in the last twenty years, to identify the net role of the market in the capitalisation of Italian and European banks. The paper is primarily a descriptive study aimed at documenting the evolution of bank capital and capital adequacy of Italian banks in a comprehensive way . Particular attention is paid to dividend policy for two reasons: on the one hand, in hindsight, dividend policy may have played a role in weakening the capital base of larger listed banks and on the other hand, for the future, should the economic crisis continue, retained earnings could be the primary source of the high-quality capital that will presumably be required to comply with higher capital ratios to be imposed in the near future. Conclusions may be particularly significant considering that the Basel committee (BIS, 2009) is proposing the introduction of an internationally agreed framework to promote capital conservation in the banking sector and a mechanism for rebuilding capital during economic recovery. The proposed mechanism is based on capital distribution constraints (i.e. no dividend payments) when capital levels fall in a buffer range above the minimum capital requirement. The paper unravels as follows: par. 2 introduces the current regulatory framework and the proposed changes; par. 3 analyses capital adequacy in the last fifteen years; par. 4 investigates dividend policy and its relation on the one hand with profitability and on the other hand with ownership structure since retained earnings could represent an important way of increasing the capital base with high-quality capital; par. 5 analyses the recourse to the market to raise new capital by Italian listed banks in the last ten years; par. 6 concludes.