No case to ban dividend payment by banks

The Reserve Bank of India has directed banks not to make any dividend payment on their equity shares from the profits pertaining to the financial year ended March 31, 2020. The idea is that in view of the ongoing stress and heightened uncertainty on account of Covid-19, it is imperative that banks continue to conserve capital to support the economy and absorb losses and, hence, not make payouts.

Existing statutory provisions

Even by the Banking Regulations Act, 1949, there are various restrictions on banks for declaring dividends.

According to Section 15, “No banking company shall pay any dividend on its shares until all its capitalised expenses (including preliminary expenses, organisation expenses, share-selling commission, brokerage, amounts of losses incurred and any other item of expenditure not represented by tangible assets) have been completely written off.”

Section 17 wants every banking company incorporated in India to create a reserve fund out of the balance of profit of each year as disclosed in the profit and loss account prepared under Section 29 and before any dividend is declared, transfer to the reserve fund a sum equivalent to not less than 20 per cent of such profit. This provision can be exempted by the government on the recommendations of the RBI.

These provisions ensure that the banking companies conserve the profits earned sufficiently so that they can be on a sound footing.

Precautions by RBI

Added to the above, the RBI also in its wisdom provides other restrictions for declaration of dividend. The RBI by its circular May 4, 2005, prescribed eligibility criteria for banks to pay dividends. The conditions are based on the Capital to Risk (Weighted) Assets Ratio (CRAR) and the Net Non-Performing Assets (Net NPA).

Banks can pay dividends if the CRAR is 9 per cent for preceding two years and Net NPA less than 7 per cent. Alternatively, CRAR of 9 per cent for the current year and Net NPA of less than 5 per cent.

There are also restrictions on the quantum of dividend. There is a matrix combining the CRAR and Net NPA to prescribe permitted dividend payout ratio. In any case maximum payout ratio can be only 40 per cent.

From the above provisions, it is clear that necessary safety net has already been prescribed by the Banking Regulations Act. In addition to this there are restrictions on the eligibility to declare and the quantum of dividend by the RBI.

Negligible dividend amount

The RBI claims that the purpose of the current restrictive directive is to conserve capital to support the economy and absorb losses as if the dividend payout is a substantial amount. Banks dividend payment is a minuscule amount. Let us take the case of HDFC Bank Ltd, which is considered a consistent profit-making lender. For the year ended March 31, 2020, the bank’s net profit was ₹26,257 crore. The bank proposed a dividend payout of ₹6,540 crore. The bank’s shareholder funds were ₹1,70,986 crore, which means this dividend is just 3.82 per cent of the capital funds.

The bank had an advances portfolio of ₹9,93,702 crore, which means the dividend amount is just equivalent to 0.65 per cent of its funds deployed as advances. So, by banning dividend payment, the bank will be able to retain just 0.65 per cent of its requirement to lend. Is it worth doing?

It is difficult to understand the total ban on dividend payment that too by all banks, irrespective of their financial results.

Banks are already following prudential norms. They maintain adequate provision for bad debts, as per RBI’s prescriptions. They maintain capital adequacy norms as prescribed. The banks can declare dividend only after making all these transfers.

A bank has various stakeholders, including shareholders. Based on the market price of shares, the dividend yield is negligible. For example, with the current share price, HDFC bank’s dividend yield is 0.18 per cent. When government banks declare dividend, a sizeable portion of it goes to the government and that will also help the economy. Anyway, when dividend is paid by any bank, the funds come back to the economic system.

Banks are dependent on its shareholders and depositors for financial resources and already depositors are marginalised with low interest rates and now with dividend curb the shareholders are also deprived of even their miniscule dividend payout.It will be interesting to know that in August 2020, the RBI board approved transfer of ₹57,128 crore as surplus to the government for the accounting year 2019-20. Now, the question arises, why as the lender of last resort, the RBI had not decided to skip dividend payment to the government in a pandemic situation.

Isn’t dividend payout an insignificant issue for the RBI when more serious problems like NPAs and wilful default loom large?

The writer is a retired banker