The finance ministry should have consulted the RBI, if at all it was necessary to modify the dividend payout ratio of PSBs for whatever reasons, to avoid the predicament being faced by the public sector banks now 

As per the report in The Economic Times (ET) dated 15 April 2013, the finance ministry, in its anxiety to bridge the fiscal deficit for the current year, has issued directions to public sector banks (PSBs) last week to pay a dividend of a minimum of 20% of their capital or net profit, whichever is higher, for the financial year ended March 2013. These instructions, coming as it does in the wake of rising non-performing assets and the poor demand for credit, have perplexed PSBs, who are in a no-win situation as these instructions affect them in two distinct ways:
 

Firstly, it affects the capital adequacy ratio (CAR) of banks:
      

The well known fact is that higher the payout ratio, lower the profits ploughed back in to the reserves. This in effect will have an adverse impact on the capital adequacy ratio of banks. Every year, to meet the growing business needs, public sector banks, starved of capital, look to the central government to fund their capital requirements and the government as the majority share holder in all public sector banks is, perforce, obliged to fill the gap by contributing to the capital needs of all the PSBs year after year. During the last three years, the government has pumped in capital as under in PSBs to keep them well capitalized as required under the norms.
                        

As per the ET’s analysis, last year, all PSBs , cumulatively paid a sum of Rs 8,550 crore as dividend to the central government, which was on an average 60% of the capital and 15% of their net profits for the year. Obviously it means that the government receives dividends from one hand and gives it back to the banks though the other hand— by way of capital— thereby bloating the capital of banks, affecting their dividend paying capacity during the lean years. If only a higher percentage of profits are ploughed back into the reserves, it not only strengthens the CAR, but also improves the book value of the shares, which in turn will reflect in their better valuation in the bourses. Besides, the need for capital keeps on growing due to the introduction of Basel III guidelines, a global banking norm prescribed by Bank for International Settlements on capital adequacy of banks to minimise financial risk. So it does not appear prudent for banks to pay higher dividend and get it back in the form of capital. 
      

Secondly, these instructions of the ministry are contrary to RBI guidelines:
 

Reserve Bank of India (RBI) has, in its own wisdom, laid down elaborate guidelines for dividend payouts by banks keeping an eye on the overall financial strength of the banks. Under the prudential guidelines applicable to all the commercial banks issued in May 2005, the RBI has given general permission to banks to declare dividends subject to compliance with the guidelines laid down by it. A few of the major conditions stipulated by RBI, inter-alia, are as under:
 

1. The bank should have a Capital to Risk-weighted Assets Ratio (CRAR) of at least   9% for the preceding two completed years and the accounting year for which it proposes to declare dividend.
 

2. Net Non-performing assets (NPA) of the bank should be less than 7%.
 

3. In case any bank does not meet the above CRAR norm, but is having a CRAR of at least 9% for the accounting year for which it proposes to declare dividend, it would be eligible to declare dividend provided its net NPA ratio is less than 5%.
 

4. The bank should comply with all the RBI guidelines regarding creating adequate provisions for impairment of assets and staff retirement benefits, transfer of profits to statutory reserves etc.
 

5. The proposed dividend should be payable out of the current year’s profit.
 

6. The RBI should not have placed any explicit restrictions on the bank for declaration of dividends.      
                                  

7. With regard to quantum of dividend payable, the RBI has laid down that the dividend payout ratio shall not exceed 40% of net profits, adjusted for any extra-ordinary profits/income and it shall be as per the following matrix.