In most sectors, regulators do not interfere in decisions on whether a company should distribute profits as dividends or retain them for growth. But global banking regulators have had reason to rethink this position after the 2007-08 global financial crisis. Banks run a cyclical and highly leveraged business, in which reported profits are a function of the accounting policies adopted by managements on investment valuation, bad loan recognition and provisions.

The 2008 crisis showed that banks which distributed liberal dividends to shareholders in good times, left other stakeholders such as depositors holding the baby, with capital shortfalls when bad times arrived. The Reserve Bank of India thus has been prudent in setting limits on dividend payouts by banks operating in India. Its recent draft circular setting out qualifying criteria for banks declaring dividends represents a substantial tightening of rules that have been in place since 2005.

The draft proposes that banks be allowed to declare dividends, only if they have met regulatory capital requirements for the last three years including the one in which the payout is proposed. Adherence to capital adequacy norms will be evaluated not just on overall CRAR (capital to risk-weighted assets ratio), but on individual components such as Common Equity Tier 1 and Capital Conservation Buffer. This seems to be a safeguard against banks boosting their capital base by tapping non-equity instruments such as preference shares or AT-1 bonds, to qualify. Post-Covid, the mandated CRAR in India for commercial banks (at 11.5 per cent), small finance banks (15 per cent) and payments banks (15 per cent) is also set much higher than the earlier 9 per cent, offering a higher margin of safety than before. RBI is also suggesting that banks stay within a net NPA (non-performing asset) ratio threshold of 6 per cent instead of the earlier 7 per cent, to become eligible to pay dividends. To ensure that reported profits and capital are not padded up by unsustainable items, bank Boards will be asked to factor in supervisory findings on asset divergence, auditor qualifications and future capital needs, before proposing dividends.

While mooting a higher capital bar for banks seeking to pay out dividends, RBI is considering slightly more relaxed norms on their dividend payout ratios. It suggests that banks be allowed to pay out 50 per cent of profits if they boast zero net NPAs, as opposed to 40 per cent earlier. Banks with net NPAs up to 1 per cent will be allowed a 40 per cent payout, with the cap set at 35 per cent for 1-2 per cent net NPAs, 25 per cent for 2-4 per cent and 15 per cent for 4-6 per cent. These tweaks are well-timed to cause minimum disruption to bank shareholders. Thanks to strong credit offtake and a balance sheet clean-up, most banks are sitting on healthy capital cushions with net NPAs of 1-2 per cent, qualifying for payouts of 35-40 per cent. The best time to tighten the screws is when things are good. RBI has done just that.

comment COMMENT NOW