Kotak Institutional Equities (KIE) sees close to negligible impact on banks from the Reserve Bank of India’s proposed update on dividend declaration guidelines slated to come into effect from financial year 2024-25.

“One of the reasons that the impact of the guideline is lower is because banks have been looking to grow their balance sheet ahead of their internal accruals. Hence, most banks are still in a capital consumption mode, which implies payout ratios are likely to be lower for nearly all banks.

“Overall, we do not see any reason for banks to change their dividend payout policies based on the current guideline,” said a KIE note issued on Tuesday, a day after RBI came with draft guidelines on dividend declaration by banks.

The RBI plans to tighten the prudential requirements relating to capital adequacy and asset quality for the declaration of dividends by banks from the accounting year ended March 31, 2025 onwards.

Dividend declaration

The RBI has laid out an updated framework on dividend declaration for banks and the repatriation of profits for foreign banks. The framework ties the payout ratios to net NPL ratios as compared to the earlier grid-based framework that compared capital adequacy levels and net NPL ratios. 

“Banks have generally been conservative on payout ratios even when we look back historically, and with net NPL ratios reaching closer to historical lows, the impact of the current guideline is negligible for the sector,” added the KIE report.

The KIE note highlighted that these guidelines have been revised in light of the implementation of Basel III standards, introduction of the prompt corrective action (PCA) framework, and the introduction of differentiated banks where the capital requirements are different. 

It is to be noted that the guidelines on payout ratios were previously updated in 2003-05 and there was a need to modify them to adapt to the current banking system.

Historically, the payout ratios have usually been closer to 20 per cent, which implies that the threshold net NPL ratio that is permissible is between 2 per cent and 6 per cent. “We currently have very few banks that have net NPL ratios higher than 2 per cent (2QFY24) and even these banks have been quite prudent in their dividend declaration,” the KIE report added.

New norm

The RBI’s new guideline for dividend payout ratios and profit repatriation for foreign banks is on the following lines: (1) the board should look at any divergence in asset classification, qualifications by auditors, current and projected capital adequacy ratios and long-term growth projections of the bank before dividend declaration; (2) eligibility criteria: comply with capital adequacy ratios for the preceding three financial years, including the financial year for which a dividend is declared and the net NPL ratio has to be <6 per cent; and (3) the payout ratio would be tied to net NPL ratios, with a higher net NPL ratio leading to lower payout ratios and vice versa. These guidelines would be applicable for dividends declared from FY2024-25.