Banks able to pay higher dividends after relaxation of reserve fund rules

The central bank has removed the requirement for both conventional and Islamic banks to maintain a reserve fund last Wednesday, which analysts and industry observers said would pave the way for banks with a higher common equity tier 1 (CET1) ratio to declare higher dividends.

PETALING JAYA: Shareholders of banks with strong capital ratios stand a better chance of being rewarded with higher dividends following Bank Negara’s move last week to scrape the requirement for reserve fund.

The central bank has removed the requirement for both conventional and Islamic banks to maintain a reserve fund last Wednesday, which analysts and industry observers said would pave the way for banks with a higher common equity tier 1 (CET1) ratio to declare higher dividends.

“Banks with higher CET1 ratio and that are able to comply with the stringent capital requirements under the ruling like capital conservation and counter-cyclical capital buffers are more capable to offer higher dividend payout,” said an industry official.

Maybank IB Research banking analyst Desmond Ch’ng concurred with the view that over the longer term, banks with strong capital ratios would be in a better position to improve dividend payments to shareholders.

“Banks no longer need to maintain a reserve fund (which is non-distributable) and provides banks with greater flexibility in managing their reserves especially for future dividend distributions, he said.

Reserve fund is the portion of the net profit that banks are required to set aside which are non-distributable. It varies between 25% and 50% of net profit depending on the size of the fund compared with banks paid-up capital. In general, the central bank would like to see financial institutions hold reserve fund as large as banks capital.

The idea of holding the reserve fund was to ensure banks are adequately capitalised. But with the Basel III requirement there is a view that banks need not hold such a big reserve fund.

Analysts, however, cautioned that in the short-term they do not foresee a flurry of dividend payouts by banks to shareholders.

Before the removal of the reserve fund, banks were not allowed to use the fund to distribute dividends but now they are more flexible to issue although they need to exercise prudence as required by the central bank amid the implementation of the capital conservation buffer under Basel III.

Among some of the banks with strong CET1 are Malayan Banking Group Bhd, Hong Leong Bank Bhd, RHB Bank Bhd, Public Bank Bhd and CIMB Group.

For financial year 2016, Malayan Banking Bhd’s dividend payout ratio was at 78.1% of its full-year net profit, CIMB Group and Public Bank’s payout ratio stood at 49.5% and 43% respectively during the same period.

Ch’ng was of the opinion that the central bank allowed for this flexibility because the Basel III capital requirements already limited the quantum of dividends a bank can declare.

“So long as the minimum CET1 ratio is complied with, any excess reserves should technically be distributable,” he said in a research note.

The research house in a note said the prevailing issue at the moment is the minimum fully loaded CET1 ratio that banks need to comply with was still unclear.

Until this uncertainty clears, it is unlikely that any of the banks will raise their dividend payouts.

Over the longer term, Ch’ng pointed out that it would undoubtedly be the banks with higher CET1 ratios that would eventually be in a better position to pay out higher dividends.

Meanwhile, CIMB Investment Bank senior banking analyst Winson Ng, who is maintaining its “overweight” stance on the banking sector, said although banks would no longer need to maintain a reserve fund, he did not expect an increase in their dividend payment due to the stringent capital requirements compliance under the Basel III requirement.

Ng said he also gathered from the industry that the central bank was stringent in approving banks applications for dividends as it wants financial institutions to maintain high capital ratios.

Although the requirement to maintain a reserve fund has been removed, the central bank expected banks to exercise prudence before submitting an application to distribute the reserves as dividend.

For the approval of banks’ application for dividend, the central bank would consider their ability to comply with the fully phased-in capital conservation buffer requirement and any other buffers that it may specify.

Under Basel III, the minimum regulatory requirement for CET1 capital ratio is 4.5%. Banks are also required to maintain a capital conservation buffer of up to 2.5% and counter-cyclical capital buffer above the minimum regulatory capital adequacy ratio.

Under the transition arrangements, capital conservation buffer would be increased gradually starting from 0.625% in 2016 to 2.5% of total capital from 2019.

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