The Bangladesh Bank (BB) has quietly initiated a series of significant banking reforms aimed at improving the overall stability of the financial system. One of the most recent measures is the tightening of regulations surrounding dividend payouts by scheduled banks, a strategic move to address some of the immediate issues within the sector.
In addition to this, BB has announced the establishment of four new departments at its head office. These new departments are designed to enhance its operational capacity and increase oversight of the banking and financial sectors, helping ensure better regulation and supervision.
Just a few days earlier, the BB introduced reforms to the exit policy for non-performing loans (NPLs), targeting defaulters whose failure to repay loans was not a result of wilful neglect or deceptive practices aimed at evading payment.
The new regulations, which strike a balance between firmness and strategic leniency, are laying the foundation for a more robust financial system. This article delves into the most recent reform concerning dividend payouts, an example of a quick yet impactful initiative.
Current Dividend Practices
Many banks in Bangladesh, particularly those struggling with non-performing loans and poor cash placements, have been known to distribute dividends that account for 10 percent or more of their net paper profits after tax. These profits are often described as “paper profits,” originating from creative accounting practices and lax regulatory oversight. They do not accurately reflect the true financial health of the institutions.
Out of the 61 banks in Bangladesh, only five achieved net profits exceeding Tk 1,000 crore in 2024. This achievement largely stemmed from a flight to safety during a period of financial instability, with returns from government securities outstripping the usual sources of income, such as net interest income.
Depositors, seeking safer institutions for their funds, prioritised financial security over profitability, and the growth of NPLs has far outpaced deposit growth for an extended period. Despite these issues, many listed banks continued to show increasing trends in dividend payments, even offering yields above 10 percent. This is especially perplexing given the challenging economic conditions and the high risk of insolvency.
Moreover, politically influential individuals have been known to extract funds from banks and launder them abroad. By the end of 2024, more than one-fifth of the total loans in the banking sector were reported as non-performing, with embezzlement by owners contributing significantly to this figure. The true value of distressed assets is believed to be two to three times higher than reported NPLs.
Despite these issues, there is a notable positive correlation between business risk and the dividend payout ratio. In other words, banks with higher risks tend to pay higher dividends, reflecting a strategy of “milking the property.” This practice, however, places greater emphasis on dividend distribution than on maintaining financial stability.
The Need for Prudence
Such practices exacerbate the long-term damage to banks already weakened by fraud and defaults. For commercial banks, a sound dividend policy is critical for maintaining a strong capital base that can absorb potential losses and meet regulatory capital requirements. In times of economic and political instability, such as the current climate, it is crucial for banks to adopt a conservative dividend policy that focuses on retaining earnings to ensure long-term stability.
BB’s new dividend policy is set to restrain 23 of the 61 banks in Bangladesh from making dividend payouts, thus protecting the interests of depositors and minority shareholders. Banks that have utilised a deferral facility to meet provisioning requirements, or those with NPLs exceeding 10 percent of their total loans, will not be allowed to pay dividends. Similarly, banks that have incurred penalties or fines due to a shortfall in their cash reserve ratio or statutory liquidity ratio will be restricted from dividend payouts.
Under the new policy, cash dividends can only be distributed from profits generated within the current calendar year. Banks with a risk-adjusted capital adequacy ratio (CAR) of at least 15 percent will be allowed to pay cash and stock dividends up to 50 percent of their net profits after tax. If the CAR is between 12.5 percent and 15 percent, this limit is reduced to 40 percent, and no cash dividends can be paid if the CAR falls between 10 percent and 12.5 percent.
Tightening Measures
These stricter regulations are particularly necessary as the BB has had to provide liquidity support to distressed banks in recent years. Following the political changes in 2024, the BB extended approximately Tk 25,000 crore in liquidity support to troubled banks to prevent a bank run. However, these banks are yet to repay the funds, and the quality of their assets continues to deteriorate amidst declining growth, high inflation, and ongoing social unrest.
The new dividend policy encourages banks to retain earnings and prioritise protecting depositors from potential risks. By fostering financial prudence, this policy will help banks navigate the challenging economic landscape.
Preparing for Deeper Reforms
While the new regulations may face resistance in the stock market, especially from short-term investors, their long-term benefits are undeniable. Strengthening banks’ capital foundations will ultimately lead to a healthier and more resilient banking sector.
These measures align with the forthcoming stricter NPL recognition criteria and the simplified provisioning framework, set to take effect in April. Furthermore, they complement the Prompt Corrective Action (PCA) framework, announced in December 2023, which aims to address banks based on the severity of their financial issues. This framework is scheduled for implementation by March 2025.
Currently, there is hope that banks will no longer be able to leverage political connections to operate without accountability, as they did under previous administrations. This is a critical moment for reforming the prudential framework, which covers dividend payments, NPL recognition, provisioning requirements, and disciplined exits.
The reform advocates for financial stability, which is being increasingly recognised as essential by both local stakeholders and international partners. As efforts to overhaul the banking system progress, the full impact of these reforms will become clearer in the coming years.
Supplementary Information:
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Non-Performing Loans (NPLs) in Bangladesh: The rising NPL ratio continues to be a significant concern for the banking sector. At the end of 2024, over 20% of the loans in the banking sector were classified as NPLs, with many of them linked to embezzlement and fraud.
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Capital Adequacy Ratios (CAR): The CAR is an important metric used to measure a bank’s ability to absorb potential losses. Banks with a CAR of 12.5% or higher are considered to have a strong capital base, ensuring greater stability in times of financial distress.
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Liquidity Support by Bangladesh Bank: In response to the liquidity crisis, the BB provided Tk 25,000 crore to struggling banks. However, these funds are yet to be repaid, and the continued instability in the banking sector may require further intervention.
