In "Banks should be allowed to pay out dividends", published as Comment in FT on February 10, 2011, William Isaac, former chairman of FDIC and chairman of LECG Global Financial Services, makes the point that paying out dividends will enable banks to raise more capital in future, and easily so, which in turn would help promote growth. The author also agrees with the need to have greater capital in the system. Hence, it is somewhat difficult to understand the author's blanket assertion that banks should be allowed to pay out dividends. There are at least two difficulties with the author's position.
Second, the idea that banks can pay dividends simply because they have now repaid TARP injections deserves some more thought. In parallel with TARP, the government back-stopped a large number of other parts of financial sector and markets, is still continuing to run the Fannie and the Freddie as "bad banks" incurring significant losses in the process, and providing a substantial lender-of-last-resort role through various forms of interventions of the Federal Reserve. Some of these have clearly benefited the economy, including the financial firms whose capitalization has improved since a complete collapse of the housing market has been averted. Assessing the economic attractiveness of banks paying dividends based solely on their balance-sheet strength - and even worse, just on their ability to repay TARP - ignores the most important lesson of the crisis: that we should strive for regulating systemic risk of the financial sector, not the individual risk of financial firms.
I agree with the author that a steady increase in rebuilding of the capital base of financial firms, rather than in an abrupt manner, has some benefits (and that Basel risk-weights are inherently flawed). But this too seems to call for dividend preservation for those firms vulnerable to systemic stress (rather than based on their Basel risk-weighted assets).