When banks need cash most they give cash dividend to avoid tax

At a time when banks need to hold more cash to strengthen their capital bases, most have declared cash dividends for last year to avoid additional taxes on stock dividends imposed in the FY20 budget.

Although the government had imposed the additional taxes on stock dividends for the sake of capital market investors, the Covid-19 outbreak has rendered it counterproductive for both banks and investors amid rising concerns of default loans. 

The pandemic has increased the risk of credit loss for banks which will ultimately hit their capital bases next year. Eroding capital bases will eventually hurt their performance in the stock market negatively affecting retail investors.

In order to prepare for challenges arising from the coronavirus outbreak, banks were supposed to declare more stock dividends to strengthen their capital bases, but the new law has forced them to declare more cash dividends instead.

Cash dividend is payment made in cash to shareholders, paid out to investors using the bank's earnings while stock dividends are more shares given to investors on top of those they already own.

As of last week, 26 listed banks declared dividends, of them, 22 declared cash dividends for last year. However, in the previous year, only 12 banks had announced cash dividends, according to Dhaka Stock Exchange (DSE) data.

Dividend declaration rate for last year was almost the same for most banks when compared to the rate in the previous year as implementation of the single-digit lending rate has hit banks' incomes.

Out of the 26, dividend declarations of 52 percent banks remained unchanged, declined for 24 percent, and increased for 16 percent of the banks.

The new law of imposing tax on stock dividends has put banks in a dilemma, said Faruq Mainuddin Ahmed, managing director of Trust Bank.

"Banks need to declare more stock dividends to improve their capital bases, but the government has put a penalty on it to increase revenues through the additional tax," he said.

So, banks either have to pay tax or pay cash to shareholders, he said.

According to the Finance Act 2019, a company will have to pay 10 percent tax if its stock dividends exceed cash dividends.

The government also imposed 10 percent tax on retained earnings and reserves exceeding 50 percent of paid-up capital – the amount of money earned from shareholders in exchange for shares – of companies.

The downside of this law is that many banks already have weak capital bases, and the banking sector will see further deterioration in the coming year due to the rise of default loans, said Ahmed.

"As a result, the declaration of cash dividends will ultimately not help stock investors; rather it will put banks in capital risk," he said.

Encouraging banks to declare cash dividends was a good decision up until the Covid-19 crisis hit the country, said a senior executive of the Bangladesh Bank.

He said that the situation has changed now. Banks' capital bases will be weaker this year as default loans are expected to jump after September.

So, declaring cash dividends will not benefit investors if the performance of banks deteriorates, he opined.

Moreover, despite a drastic fall in default loans, thanks to the discounted package for loan rescheduling, banks' capital bases were still below the regulatory limit in December last year.

The average Capital Adequacy Ratio, which measures risk-weighted assets of the banking industry, stood at 11.57 percent in December 2019 – below the regulatory requirement of 12.50 percent according to Basel III.

Basel III is an international business standard that requires financial institutions to maintain enough cash reserves to cover risks incurred by operations. The Bangladesh Bank set December 2019 for every bank to bring the Capital Adequacy Ratio to 12.50 percent.

According to central bank data, 15 banks failed to maintain the Capital to Risk (Weighted) Assets Ratio that year. Among them, five were state-owned, eight were private and two were specialised banks.