Payout Restriction and Bank Risk-Shifting

This paper studies the effects of bank payout restrictions, imposed during the COVID-crisis in 2020, on risk-shifting incentives within US banks. Using a high-frequency differences-in-differences empirical strategy, I show that when share buybacks are banned and dividends restricted for Fed-supervised banks, their equity prices fall while their CDS spreads and bond yields decline differentially. In sum, these results indicate that payout restrictions shift risk from debt towards equity holders.  Consistent with this channel, I further find that after lifting the restrictions, both effects revert.  

Moreover, removing the restrictions is followed by higher payouts and by differentially stronger growth in riskier (non-investment grade) lending, showing that payout and risk-taking choices are complements during this episode. While lending portfolios become riskier, spreads charged on loans decline, suggesting risk-shifting by bank equity holders.