Banking reforms on the move

The Bangladesh Bank has embarked on a series of banking reforms with quiet determination. Most recently, it has tightened regulations regarding dividend payouts by scheduled banks, exemplifying the strategy of seizing low-hanging fruit in the pursuit of structural reforms.

Concurrently, an announcement was made to establish four new departments at the BB head office to bolster its operations and enhance oversight of the financial sector.

For all latest news, follow The Daily Star’s Google News channel.

Just a few days prior, BB reformed the exit policy for non-performing loans (NPLs), specifically targeting defaulters who were not deemed to have failed in repayment due to wilful neglect or deceptive practices to evade payment.

The new regulations introduced by the BB, combining firmness with strategic leniency, lay the groundwork for a sturdy financial system. This article focuses on the most recent reform concerning dividend payouts, an addition to BB’s collection of quickly attainable yet impactful initiatives.

Observed dividend practices

Banks notorious for holding not just bad loans but also poor cash placements have distributed dividends amounting to 10 percent or more of their net paper profits after tax. These profits, termed as ‘paper’ due to their origins in creative accounting and lenient regulatory oversight, do not reflect real earnings.

Out of the 61 banks in Bangladesh, merely five achieved net profits exceeding Tk 1,000 crore in 2024, primarily due to a flight to safety amidst financial instability. The net interest income, typically the main revenue source for banks, paled in comparison to the returns from government securities.

Depositors shifted funds to institutions perceived as more secure, prioritising financial safety over profitability. Growth of nonperforming loans has outpaced deposit growth for longer than old, aged memories can recall.

Yet, practices in listed banks of Bangladesh show an increasing trend in dividend payments. This is puzzling with pieces that just don’t fit together. In a system plagued by tight liquidity, pervasive insolvency, and shaky confidence, positive and often high (above 10 percent) dividend yields observed in reality for a large number of listed financial corporates challenge understanding the drivers of their dividend policy.

Politically influential individuals took out funds and laundered them abroad. At the end of 2024, over one-fifth of the total loans in the banking sector were sour, largely due to embezzlement by owners. Distressed assets are probably two and a half to three times the reported NPLs.

This does not prevent cash dividends. On the contrary, there is a significant and positive association between business risk and dividend payout ratio in the banking sector. Banks with higher business risks tend to pay higher dividends.

This reflects a “milking the property” strategy. Several banks appear to be prioritising dividend payments over maintaining financial stability.

Towards better prudence

These practices exacerbate the long-term damage to banks already weakened by fraud and defaults. For commercial banks, a sound dividend policy is essential for maintaining a robust capital base to absorb potential losses and comply with regulatory capital requirements. During times of economic and political instability, such as those we currently face on a daily basis, a conservative dividend policy that emphasises retaining earnings is imperative.

BB’s new dividend policy could reportedly restrain 23 out of 61 banks from making dividend payouts at the risk of depositors’ and minority shareholders’ interests. Banks that have taken a deferral facility to maintain provisioning requirements cannot pay dividends, nor can those with NPLs exceeding 10 percent of their total loans or incurring penalty or fine due to shortfall in the cash reserve ratio and statutory liquidity ratio.

Cash dividends are restricted to the profits generated within the current calendar year; they cannot be distributed from past accumulated profits. Banks that maintain a risk-adjusted capital adequacy ratio (CAR) of at least 15 percent can issue cash and stock dividends up to 50 percent of their net profit after tax. This limit drops to 40 percent if the CAR is between 12.5 percent and 15 percent. No cash dividends can be paid if the CAR falls between 10 percent and 12.5 percent.

Such tightening is particularly warranted when the BB is pressed to provide liquidity support to distressed banks. After the political changeover last year, the BB provided money to troubled banks to prevent a bank run. It has provided around Tk 25,000 crore in liquidity support to ensure they could meet withdrawal demands.

The BB needed to make sure such withdrawals do not include cash dividends paid by liquidity and capital-constrained banks. The crisis-hit banks are yet to repay the funds to the BB. Further asset quality deterioration is on the cards with declining growth, high inflation, and continuing social unrest.

The dividend payout reform encourages banks to retain earnings. By prioritising protecting depositors from potential risks, it should help banks navigate challenging economic conditions by promoting financial prudence.

Readiness for deeper reforms

Although the new regulation might initially face backlash in the stock market, particularly from short-term-focused investors, their long-term advantages for both the economy and the market are remarkable. Enhancing banks’ capital foundations will strengthen the overall health of the banking sector.

These measures align with the upcoming tighter NPL recognition criteria and the simplified provisioning framework set to be implemented this April. They also complement the Prompt Corrective Action (PCA) framework announced in December 2023 with a commitment to implement by end March 2025. The PCA outlines specific strategies for addressing banks based on the severity of their balance sheet issues.

Currently, it is hoped that banks can no longer leverage political protection to operate as freely with impunity as they did under the previous regime. Now is opportune moment for reforming the prudential framework encompassing dividend payments, NPL recognition, provisioning requirements, and disciplined exits.

Those disadvantaged by these reforms are currently at a significant political disadvantage. The call for financial stability has never been stronger, both from local stakeholders and international partners.

These reforms are especially handy as comprehensive efforts to overhaul the banking system, including the BB, are in progress, albeit still in their infancy. The impact of these changes will become more apparent once a substantial number of reforms have been sustainably implemented over time.

The writer is a former lead economist of the World Bank’s Dhaka office

_{Images are for reference only.Images and contents gathered automatic from google or 3rd party sources.All rights on the images and contents are with their legal original owners.}