RBI Proposes Relaxation Of Bank Dividend Payout Norms

RBI Proposes Relaxation Of Bank Dividend Payout Norms

Context:

The Reserve Bank of India (RBI) has introduced new guidelines suggesting that banks with a net non-performing assets (NPAs) ratio below 6% can declare dividends. The current requirement mandates a ratio up to 7% for dividend eligibility.

Relevance:

GS-03 (Economy

Highlights:

  • Basis for Changes: The proposed alterations stem from the implementation of Basel III standards, revisions to the prompt corrective action (PCA) framework, and the introduction of differentiated banks. These changes are expected to be effective from the financial year 2025 onward.
  • Capital Adequacy Criteria: Commercial banks must maintain a minimum total capital adequacy of 11.5% to be eligible for dividend declaration. Small finance banks and payment banks need a 15% adequacy, while local area banks and regional rural banks require 9%.
  • Potential Increase in Dividend Payout Ratio: The RBI is contemplating raising the upper limit on the dividend payout ratio. It might be increased to 50% if a bank has zero net NPAs, up from the existing cap of 40%.
  • Stringent Dividend Requests: The draft guidelines make it clear that the RBI will not entertain any requests for “ad-hoc dispensation” regarding dividend declarations, signaling a stringent approach towards such requests in the future.

Dividend Policy:

  • Dividends are a portion of the company’s profits paid out to its shareholders as a return on their investment.
  • A dividend policy is a set of guidelines and decisions that a company or organization establishes to determine how much of its earnings it will distribute to its shareholders in the form of dividends.
  • This policy is crucial in shaping the financial strategy of a company and can impact the perception of investors, as well as the company’s stock price.

India’s Dividend Policy:

  • Legal Framework: The central bank in India adheres to a dividend policy outlined in Section 47 (Allocation of Surplus Profits) of the RBI Act.
  • Surplus Transfer: This policy governs the transfer of the central bank’s surplus to the government, with the amount determined after accounting for provisions such as bad debts, depreciation, and contributions to funds.
  • Recent Transfer: Notably, the most recent transfer amounted to Rs 306 billion, which was significantly less than the previous year’s transfer of Rs 659 billion, raising concerns about the government meeting its budget targets.

Concerns with Government’s Demand:

  • Budget Shortfall: Faced with a substantial shortfall from the budget target, the finance ministry sought an additional Rs 130 billion from the RBI.
  • RBI’s Response: Initially resistant, the RBI eventually yielded to the government’s request, transferring Rs 100 billion as an interim dividend.
  • Deemed Unwarranted: Despite these actions, the government’s insistence on pressuring the RBI for a specific policy is considered unwarranted. The central bank had previously expressed its commitment to developing a structured “draft economic capital/provisioning framework” in its annual report for 2015-16 to systematically assess risk-buffer requirements.

Non-Performing Assets (NPAs):

  • Non-Performing Assets (NPAs) are debts that, in most instances, are categorized as non-performing when loan payments have not been made for a minimum period of 90 days.
  • This situation is exacerbated by what is known as a twin balance sheet crisis, where banks face severe stress, and corporations are overleveraged to the extent that they struggle to repay their loans.
  • Categories of NPAs:
    • Substandard Assets: These are assets that remain classified as NPAs for less than or equal to 12 months.
    • Doubtful Assets: An asset falls into this category if it remains in the substandard category for 12 months.
    • Loss Assets: Identified by the bank or the Reserve Bank of India (RBI) as assets where a loss has occurred, yet some residual value may still exist. In these cases, the loan has not been completely written off.