In the year 2010, banks had a tendency to declare high dividends, even hiding their financial weaknesses, to allow shareholders to take out profit ignoring the real financial capacity.
The new dividend policy issued by the Bangladesh Bank recently revealed the real financial capacity of banks, as dividend is now linked with financial strength.
Only 12 out of 30 listed banks in the country have the capacity to declare a maximum of 30% dividend for last year complying with the dividend rule. These banks are – Al-Arafah Islami Bank, Bank Asia, City Bank, Dutch-Bangla Bank, Dhaka Bank, Eastern Bank, Jamuna Bank, Mutual Trust Bank, Prime Bank, Pubali Bank, Southeast Bank and Trust Bank.
In 2010, when the market was booming, half of the listed banks declared dividends as high as 30%-95%, while 11 banks declared over 20% dividend.
Even though there was no rule about declaring dividend previously, the Covid-19 pandemic has brought the Bangladesh Bank to the realisation that shareholder directors must be compelled to concentrate on banks' performance to get reward from public money.
According to the new dividend policy, a bank can declare a maximum of 30% dividend including 15% cash for shareholders only if it can maintain a minimum of 15% capital adequacy ratio (CAR).
Despite having provision forbearance, the average industry CAR declined to 11.64% in December last year from 11.94% in September the same year. The capital base is assumed to deteriorate further in the coming days as regular loan classifications resumed from January this year which will increase provisional burden, eroding capital base.
The new dividend policy has given rise to debate in the market. Managements of banks are happy with the policy because it will strengthen their companies' financial health. Shareholders, on the other hand, have reacted rather negatively to the decision which has already been reflected in the stock market. Prices of banking sector stocks have been in downtrend since the policy was issued.
The dividend policy that the Bangladesh Bank issued on 7 February this year, however, has given a clear picture of the real capacity of banks in terms of declaring dividend.
For instance, National Bank – a listed private commercial bank – that had declared 95% dividend for its shareholders in 2010 is currently not capable of declaring over 15% dividend for the year 2020 as it does not comply with regulatory requirements in maintaining capital base in line with the new dividend policy.
Moreover, if the bank takes provisioning forbearance, it will not be allowed to declare more than 12% dividend, according to the dividend policy.
Banks are required to earmark a portion of their profit as provision to tackle default loan risks and some banks take deferral from the Bangladesh Bank when they fail to maintain it.
The inability of National Bank to comply with the regulatory requirements reflects how the company had been declaring a high dividend ignoring its weak health.
The weak financial health of the bank has a reflection in its share price as well. The share price of the once highest dividend declaring bank is now the lowest among all listed banks in the stock market.
Each share of the bank has been trading at Tk7, far below its face value of Tk10.
National Bank's CAR – the ratio of a bank's capital to its risk – stood at 13.3% in December last year after making slight improvement from 12.63% in September, thanks to provision forbearance amid suspension of loan classification throughout the year.
The Bangladesh Bank has tightened dividend policy for banks to counter a probable wave of default loans in the coming months as an aftershock of the pandemic, said a senior executive of the central bank.
"Banks have to build their capital to tackle unforeseen losses. Capital may increase in two ways — fresh investment by sponsors and retention of earnings by banks," he observed.
"But because of legal barriers, both ways are now complex for banks. For instance, the bank company act allows an individual director to hold a maximum of 5% shares personally and 10% with family, which is a barrier to injecting fresh capital by increasing share holdings.
"Meanwhile, the issue of retaining earnings is costly for banks at present, as the government in the last national budget imposed a 10% on retained earnings if they exceed 70% of profit."
In this situation, the Bangladesh Bank has tightened the dividend policy to increase the banks' capital base, which will ultimately extend their lending capacity, he explained.
Earlier, in September last year, the central bank showed its strict stance on dividend declaration by denying the dividend proposal of Rupali Bank for the year 2019, landing the listed company to junk stock from "A" category.
Despite having capital shortfall, the board of the bank approved a 5% stock dividend, which goes against the dividend policy. The practice of declaring dividend despite poor financial health had been going on for long but the Bangladesh Bank has put a stop to this by issuing the dividend policy.
After the dividend proposal of Rupali Bank was scrapped by the regulatory authority, the share price of the bank has continued to fall, reaching the range of Tk24-25 each currently from above Tk30 several months back.
Even though banks appear to be more interested in declaring dividends despite suffering losses or having capital shortfalls, companies of other sectors show the opposite behaviour.
For instance, newly listed telecom company Robi Axiata decided not to declare a dividend for the year 2020 despite seeing a sevenfold jump in its annual profit.
The company preferred cash retention within the business instead of its stock market image in the first year of listing.
The stock market shareholders reacted negatively to the decision, causing an immediate tumble in share price after the information was disclosed last month. Addressing the issue, Robi's Managing Director and CEO Mahtab Uddin Ahmed requested general investors not to consider dividend as the only indicator of a company's performance.
Ahsan H Mansur, executive director of Policy Research Institute (PRI), has welcomed the new dividend policy, saying, "The Bangladesh Bank has linked dividend with banks' performance, which is good for companies."
The new policy will make directors and shareholders focus on improving their company's performance to get a good dividend, he observed.
He further added that shareholders should be more educated and focus on value of share instead of dividend.
"Retention of earnings will increase the value of shares, which will bring shareholders more benefit."
Criticising the National Board of Revenue's (NBR) decision to impose 10% tax on retained earnings, he said the NBR panalises companies for not declaring cash dividends for shareholders, which is not good for the business.
Impact of the new dividend policy on stock prices
Banking sector shares experienced a big shock following the policy declaration.
Bank shares lost a market capital of Tk2,100 crore in the last one month.
Out of 30 listed banks, shares of 13 banks are currently trading close to their face value of Tk10 or below, according to the Dhaka Stock Exchange (DSE).
What is in the policy?
According to the new policy, banks that will be able to maintain at least 13.5% capital without taking any deferral facility can announce up to 25% dividend, while the capital requirement in the previous circular was 11.25% for 15% dividend.
Banks that are not under any deferral facility and able to maintain a minimum of 11.87% capital can declare a maximum of 15% dividend including 7.5% cash.
Banks that have a minimum of 12.5% capital base and have enjoyed deferral facility can declare highest 12% dividend including 6% cash.
Banks with a minimum 11.87% capital base can declare a highest 10% dividend with 5% cash.
Banks with less than 10.62% capital base will not be allowed to declare cash dividend but can give a maximum of 5% stock dividend.