THOSE brave enough to believe that banks are not doomed to fail, and that the share prices of many will stage handsome recoveries this year, can glean comfort from the dividend yields. Investors in banking shares have long been kept warm by dividend income higher than the market average, but the share price slumps of recent months mean that the yields are now very attractive indeed. The FTSE banking sector gives an average of 5.5 per cent. It is typical for London-quoted stock to yield about 3 per cent.

Not only is the income nice in itself, it may also suggest that the stocks are cheap and due upward revaluation. Shares in Royal Bank of Scotland have to double in price if its dividend yield is to fall in line with historic averages.

Lloyd TSB has given investors dividend delight for years, but it, too, is higher than normal right now. Shares in Barclays and HBOS could jump from 500p and 730p to 900p and £12 respectively if the market rediscovers respect for these institutions.

Of course, all bets on a recovery for banking sector shares would have to be called off if banks began cutting dividends. The handsome yields will materialise only if payouts remain at established levels, or improve.

Some observers will be tempted to argue that the current yields suggest that the market is already assuming that dividends will come under the cosh. The capital values of shares may be insulated from further falls. If dividends are halved, yields will move back to the historic norms without any share price deterioration. Since lower dividends would also be more easily affordable, the capital value of banks could be enhanced. It is more likely, however, that dividend cuts would send investors into paroxyms of fear. Yields would be likely to stay the same, or go higher, as share prices slide by at least the same proportion as dividends are sliced.

Dividend cuts are not, as yet, likely to be widespread. But the danger is palpable. UBS, the Swiss bank, has given shareholders notice that they will not receive the same income this year as they did last year. London and Scottish Bank, a London-listed debt collector, is in the same boat.

Reduced dividends help to rebuild banks’ capital strength, now being knocked hard by the credit crunch. Some are, or will be, obliged to call on shareholders to bolster their finances. Several have tapped the wealth accumulated in the Middle East and the Far East, and it is odd to take cash with one hand and give it away with another. Those worried about the wider economic impact of credit troubles may welcome cuts to dividends. They will if it means that banks retain the ability to lend to wealth-creating corporate customers. Banking regulators may be comforted, too. “Isn’t it time for Wall Street’s limping titans – Merrill Lynch, Citigroup and Morgan Stanley – to follow UBS and scrap their dividends?” asked Hugo Dixon, of breakingviews.com , the financial analysis website.

Now UBS has set the precedent it will be easier for others to follow suit. Most eyes are on the big beasts of Wall Street, but if Merrill, Citigroup and Morgan add to dividend depression, UK banks would find it easier to cower in the shadow of the unfortunate leadership provided by UBS.

But bankers, in common with all other companies, are employed by shareholders and must put their needs first. If this sounds selfish, bear in mind that banks will be unable to perform public service without shareholders’ capital. Banks must, surely, ensure that they can support their own interests before aiding others.

Banks, in common with other companies, would not default on interest payable on bonds. Damning conclusions are drawn about the strength of companies that fail to honour coupon payments. How much less discreditable is it to let shareholders down in the same way? Not much.

Bank shares will remain marooned until the extent of the credit crunch becomes clearly visible. Investors who think that the crunch looks worse than it will turn out to be, and that bank boards know better than to cut dividends unless absolutely necessary, should buy.