When a bank loses money and is forced to raise capital, should it still pay its shareholders a dividend?

That's the question many large banks are being asked these days, as they face a tricky balancing act: Risk the stigma attached to cutting a dividend and use the money to bolster badly needed reserves instead, or keep doling out funds to investors even as the balance sheets and income statements suffer.

So far, there has been little consistency among the big banks in their strategies, but that may change as regulators step up the pressure on them to preserve their capital.

Last week, Citigroup announced that it lost $5 billion during the first quarter after losing $10 billion during the fourth quarter. While it did cut its dividend late last year, Oppenheimer analyst Meredith Whitney thinks Citigroup should consider eliminating it altogether.

Whitney estimates that the bank will earn $1.73 per share less this year than it will pay its shareholders in dividends. "How anyone, let alone [Citigroup's] management and the board, can believe that [Citigroup's] dividend is safe given this earnings scenario is beyond our comprehension," she wrote in a report this morning.
 
Bank of America announced this morning that despite its write-downs and trading losses, it still managed to report a profit during the first quarter, albeit one that's 77 percent lower than last year. But it did not announce plans to cut its dividend in order to preserve capital.

Dwight Cass of Breakingviews.com wonders if Bank of America chief executive Ken Lewis might be making a mistake by leaving the dividend alone.

The bank's $11.8 billion in annual dividends amounts to a whopping 6.8 percent yield. "If B of A trimmed its dividend by a bit over 20 percent, to the level it paid out just two years ago, it could save around $2.5 billion a year," Cass writes.

Of course, cutting a dividend is never a welcome option. Shareholders come to rely on the quarterly payments, and once a company begins paying one, shareholders expect it to only grow—not shrink.

But in times like these, some banks are rightly throwing dividend expectations out the window. Wachovia reduced its payout by more than 40 percent after it reported a loss and $7 billion in raised capital.

National City and Washington Mutual both chose to nearly eliminate their dividends as they've been forced to turn to investors for more capital. Both are maintaining a nominal payment of just a penny per share.

When asked during a conference call why it bothered to keep such a paltry dividend, WaMu chief executive Kerry Killinger explained that it's to prevent certain income-oriented shareholders (such as dividend-based mutual funds) from being forced to liquidate their holdings.  

The dividend cuts among struggling commercial banks may have only just begun. In her Citigroup report, Whitney explains that if losses persist, the banks will need to get permission from their regulators in order to keep paying a dividend at all.