What empty streets and the virus mean for our bank dividends

We don’t like banks

Who lends you money to buy your first home, start your business?

Who gives you a savings account, pays you interest, gives a safe place to receive your salary and an easy way to spend it? The banks.

For all that they do we don’t like them.

Why? Well, for one thing, they always seem to be making massive profits and we know that profit comes from us. That holds true unless you’re a shareholder, then they aren’t so bad again.

We have a complex relationship with the banks.

How the banks make a profit

Let’s look at how they make that profit and what’s potentially going to happen.

Banks borrow money – partly from us (our savings and transaction accounts – that’s why we get interest) and partly from overseas markets. They lend that money out for more than they borrowed it at. While rates move up and down, the difference between what they borrow and lend at is pretty constant. It’s called the net interest margin and it’s about 2%.

When interest rates are really high, we borrow less – we just can’t afford to pay the interest. If we borrow less the bank makes less because they make +/-2% of lower borrowings.

When interest rates drop, we borrow more, quite simply, because we can. As we borrow more the bank makes more because they make +/- 2% of higher borrowings.

So, all things being equal, lower rates = higher profit for banks. But there’s a point where rates get so low that it eats into the net interest margin. That’s exactly where we are now. The other thing eating into profits is when the people who have borrowed money (us) don’t or can’t pay it back – bad debts. That’s going to become more of an issue as the lockdown continues.

Less profit means lower dividends

Eating into the profits is bad when you’re a shareholder waiting for your dividends. What’s going to happen? Logically? Lower, deferred or no dividends. We’ve seen regulators in the UK and New Zealand prevent banks from paying dividends. Will we be next, I’d bet my house on it (the one the bank lent me the money to buy) – particularly in light of APRA’s recent guidance about prudent capital management and stress testing.

What are we going to do about it?

In part, we are going to have to get used to the fact that we may need to draw on savings and tighten the purse strings. We will also have to shift, change, pivot, to find new places to get some of the income we used to get from bank dividends. Have a think about those parts of the economy that haven’t been as severely affected, those businesses that continue to tick along. They’re there, there are just less of them and they’re a fraction harder to find.

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