Dividend Payout Decision and Banks’ Resilience

Bangladesh Bank (BB) has recently issued a circular stipulating the conditions for commercial banks to comply with while deciding on dividend payment. According to the new circular, banks are allowed to pay a dividend if their paid-up capital is two thousand crore taka or more.

Additionally, there is a condition that those banks which have the means of paying a dividend can pay a maximum 50% cash dividend, meaning the rest can be paid as a stock dividend. Decision criteria on banks’ dividend payments came in at such a crucial time when the country's banking sector and capital market are both in very bad shape.

The bank’s dividend payment is considered to have a simultaneous implication in both the banking sector and the stock market, as the former’s capital base is directly impacted by the dividend payout, while the latter provides a benefit for the shareholders.

Dividend payment is a normal course of business for companies. What is the board's absolute decision, although dividend payment criteria as stated in the company's articles of association are complied with? Regulators should not have any role in dictating to the banks in the decision-making process for dividend payments. However, what the regulator can do is bind the banks to strengthen their capital base and thus secure the depositors’ money. Now a question arises: why is BB required to issue a circular in this regard? The answer to which is simply the failure of the board of directors' corporate responsibilities. We have experienced that in our country, the central bank plays a role in the operation of commercial banks that it is not supposed to do. On the other hand, the management of commercial banks is not found to have performed what they are required to perform. Had the board of directors and management of banks ensured the strongest capital base and thus ensured a resilient banking system, BB would not have issued a circular stipulating conditions for banks’ dividend payment.

BB has probably issued a circular with an underlying objective of securing banks’ positions and benefitting the country's capital market. However, the conditions as stipulated in the circular are not found effective in many situations. Condition of maintaining paid-up capital Taka two thousand crore does not make sense, because capital is only one of many components which ensure the bank’s soundness. For example, capital-to-deposit ratio, total assets, asset quality, percentage of NPL (non-performing loan), and adequate provision are equally important factors which, along with capital base, determine the strength of any bank. If all these factors are not inclusively considered and capital is taken into consideration as an isolated measure while making a decision on dividend payment, the desired result cannot be achieved.

If this circular is followed in making dividend decisions based on capital requirements, many good banks may not be eligible for paying dividends while other bad banks may declare dividends. This situation, which may seem complex, can be illustrated with one hypothetical example. ABC Bank has total deposits of Taka 30 thousand crore, loans of Tk 25 thousand crore, NPLs of Taka 8 thousand crore and paid-up capital of Taka 2 thousand crore. On the other hand, XYZ Bank has total deposits of 15 thousand crore taka, loans of 12 thousand crore taka, NPLs of 500 thousand taka and capital of 1,800 crore taka. Information used in the example states that XYZ Bank is in a better-off situation with a 12% capital–deposit ratio, 4% NPL and 80% loan–deposit ratio. On the other hand, ABC Bank is in a very bad shape with a 7% capital deposit ratio, a 32% NPL and an 84% loan-deposit ratio. According to the condition of circular ABC Bank, although in bad shape, it will be able to pay a dividend, whereas XYZ Bank, in spite of being in very good shape, will not be able to pay out a dividend. Besides, as per BASEL III, a bank's capital requirement is determined based on risk-weighted assets, so establishing a flat capital requirement cap of Tk 2 thousand crore may be contrary to BASEL compliance.

The condition of paying a 50% cash dividend might have been taken with the dual purpose of keeping the bank safe and benefitting small investors in the stock market, but the reality is that cash dividends always give more benefit to the board of directors and large shareholders than small investors. Because historically, seventy to eighty per cent of shares are held by either board members or large investors, while only twenty to thirty per cent of shares are held by small investors. So, if a bank requires taka one thousand crore for paying cash dividends, seven to eight hundred crore will be taken by the board members and large investors, while only two to three hundred crore will be distributed among the small investors. Whereas consequential impact is depleting bank’s capital by the cash dividend amount.

BB has issued this circular in such a critical time, when the country’s banking sector is facing a tough situation. Many banks’ existence is at stake. Some banks have been failing to return money as per depositors’ demand, an unprecedented incident in the country’s banking history. NPL has been alarmingly rising, and provision shortfall and capital adequacy have become persistent problems for many banks. A forceful attempt was taken to merge a few banks without considering suitable alternative options, which has not produced any fruitful result. Rather, it turned the situation more chaotic. The whole banking sector is in great problems and, therefore, calls for recovery measures, which, among others, include strengthening banks’ capital base. Banks can survive any adversity if their capital base is very strong. This can be achieved by avoiding cash dividend payouts, increasing provisions and raising reserves as part of capital. Even the main purpose of Basel III is to strengthen banks’ capital base. Allowing banks to pay out dividends, particularly cash dividends, may not help. So, BB should reconsider the conditions of the circular.