Last March, the Bangladesh Bank decided to increase bank’s maximum cap on paying dividends by 5 per cent. Previously banks were allowed to pay a maximum dividend of 30 per cent but following the central bank’s recent decision, banks will now be able to pay dividends up to 35 per cent to their investors. This move apparently seems to be a very good initiative, particularly for the small investors who will receive higher returns on their investment. It is expected that this move by the central bank may bear a positive impact on the country’s capital market, specially the stock market, where the banking sector captures the highest market capitalisation. Banks’ share price rise influenced by higher dividend payout will result in a considerable upward push in the overall stock price index. However, to what extent this decision of increasing banks’ dividend payout ratio will impact positively the rising capital market in the days to come, remains to be seen. Because, stock market behaviour is not always based on financial factors as there are many non-financial factors which extensively influences the movement of stock price index.
Not too much regulation, rather stringent enforcement: Decision of declaring dividend is exclusively internal affairs of the companies’ including private banks where regulators should not have any say and this is the standard corporate practice followed all over the world. However, our country’s scenario is completely different where there is a tendency and market perception of always pointing fingers at the regulator for any failure of the market players regardless of being relevant or irrelevant with the central bank. Therefore, the Bangladesh Bank has to step up their on-sight and off-sight supervision which covers many areas, which should not be the role of a central bank. This practice may ostensibly seem to be appropriate but in reality, it works as a deterrent towards practicing good governance in banking sectors which is far from playing the role of self-regulatory organisations (SROs). It may be mentioned here that a bank is categorised as quasi-SROs because this sector being completely different from any other business has to run operation strictly complying with many national and international rules and regulations. In the industry, market players and regulators have two distinct roles and responsibilities, so if each of them play their due role, too much supervision is not required from the regulator. The regulator will make necessary rules and regulations facilitating a congenial business environment where market players will perform meticulously complying with those rules and regulations. Any violation or breach will be dealt with strictly by the regulators. When this standard practice is not followed, problems arise and regulators have to interfere in many areas which is happening in our banking industry.Bank’s dividend means less cash-in and more cash-out: Dividend is declared from the profit generated from normal business operation and this is applicable not only to the banks but also to any business operation. However, a component of a bank's profit is completely different from other business, as the lion share of a bank's profit comes from the interest accrued and earned on loans and the advance extended by the bank, while others profits come from the sale of goods and services. In standard practice of bank business, borrowers utilise borrowed money and pays interest accrued thereon in cash, which means that the interest actually paid in cash by the borrower is only taken into income. Unfortunately, this practice is hardly followed in our country’s banking business as borrowers rarely physically pay cash for payment of interest accrued on their outstanding loans, instead banks debit the borrowers’ loan account for the interest and then take it into income. So, banks generate and recognise revenue and take into income without receiving any cash inflow, just by increasing the borrower’s loan balance. On the other hand, when banks declare and pay dividends, they have to pay in cash, so dividend payment results in a bank's cash outflow. So, the bank receives less cash or no cash as profit but pays out cash for dividend although stock dividend does not involve cash.
Banks’ dividend payout with NPL causes provision shortfall: While calculating bank’s profit there is some sort of loophole or maneuvering approach specially in taking interest into income through regularising classified loans which is in fact non-performing loans (NPL). Regularising NPL through various measures, including rescheduling, is a very common practice in our banking industry. Whenever a bank classifies any loan as either substandard or doubtful or bad, the bank cannot take interest accrued thereon into its income, rather place it under separate suspense account which can entirely be taken into income when the classified loans are regularised. Regularising NPL through rescheduling with minimum down payment commonly happens in our country’s banking industry. This practice eventually inflates bank’s profit which should not be treated as actual / realised profit. It is even learnt that in many cases, interest taken into income from a suspense account is higher than the down payment amount, whereas principal loan amount remains the same, i.e. no adjustment / reduction. I do not understand how our borrowers accept this type of regularisation of loan where down payment does not reduce their loan balance at all. In an accounting standard, any payment to the NPL account will first be applied to the principal adjustment and if anything left after full and final adjustment of the entire loan balance, may be taken into income. This is because the principal balance of a loan account is the part of depositors’ money which must receive preference over the owners’ interest. Unfortunately, this practice is not followed in our banking operation, rather, interest from suspense account is taken into income through rescheduling of NPL. After certain time, same situation prevails as most loans regularized through rescheduling goes back to where it was i.e. NPL. In the meantime, banks through this maneuvering process, are able to increase their annual profit, part of which is taken out through declaration and payment of dividend and bonus to the employees which eventually causes provision shortfall. Although there is a difference between theoretical provision shortfall and actual provision shortfall, as the former is calculated based on Bangladesh Bank circular, while the latter is calculated to cover the bank’s losses likely to arise from non-realisation of any loans which is in fact NPL. So, banks may not face any theoretical provision shortfall but must face actual provision shortfall because of increasing profit with unrealised interest on loans and paying higher dividend. Needless to say, our banking sector is struggling with enormous NPL and is not capable of managing NPL due to actual provision shortfall. Because there is only one acceptable means of managing NPL, either through recovering outstanding loans or completely writing off provisions retained against respective loans or from future earning with the help of third / govt. party. There is no other way to treat NPL.
Bank’s Dividend is a new financial paradox: In financial theory, dividend payout is always considered a financial paradox because higher the dividend payout ratio, lower the growth prospect which is derived through reinvestment of reserves and surpluses accumulated by maintaining lower dividend payout ratio. On the other hand, higher dividend payout means higher stock price which actually causes wealth maximisation. Similar financial paradox with a different perspective is experienced in a bank's dividend payout. If a bank with substantial NPL follows a higher dividend payout ratio, it will always face an actual dividend shortfall although retail shareholders will be happy with receiving a higher dividend. Banks pursuing higher dividend payout ratio, will always remain vulnerable with enormous NPL which the bank will have to fix today or tomorrow. On the other hand, banks maintaining lower dividend payout ratio, will remain relatively better off as it will be able to increase their actual provision which will immensely help the bank properly manage NPL and will thus consolidate the bank's overall position in the future. So, the bank's dividend payout ratio is a new financial paradox and its magnitude has somewhat risen due to the recent decision from Bangladesh Bank.
The writer is a banker