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RBI’s draft dividend cap for NBFCs may irk market, but bears rewards

While dividends may not be justified in FY21 given the pandemic, the RBI’s move ensures that shareholders do not get undue returns at the cost of the business even in good times. Photo: Abhijit Bhatlekar/MintPremium
While dividends may not be justified in FY21 given the pandemic, the RBI’s move ensures that shareholders do not get undue returns at the cost of the business even in good times. Photo: Abhijit Bhatlekar/Mint

  • While some big NBFCs are unlikely to get hit, others may have to raise capital or reduce bad loans
  • Analysts believe the new norms, if implemented in FY21, would increase write-offs of troubled loans

India’s banking regulator has proposed a rule that non-bank lenders achieve key balance sheet health thresholds before they distribute their earnings to shareholders.

In a draft proposal, the Reserve Bank of India (RBI) has linked the extent of dividend a non-banking financial company (NBFC) can pay to its shareholders with its capital adequacy ratio and net non-performing asset (NPA) ratio.

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Even the best-performing large NBFCs cannot have a dividend payout ratio of above 50%, if the draft norms turn into actual regulation. What’s more is that the NBFCs will need to have over 15% capital adequacy ratio to even qualify to pay dividends. The move has implications for all NBFCs, especially the large ones.

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In short, if two key parameters of balance sheet health do not look good, lenders have no business rewarding shareholders.

Understandably, investors of NBFCs aren’t too happy considering that good times may not bring big returns anymore. Shares of large NBFCs weakened on Thursday and the Nifty Financial Services Index dipped by about 1%. That said, the draft norms ensure that NBFCs are strong and will increase their credibility, according to analysts.

All large NBFCs will need to have more than 15% capital adequacy ratio and net NPA ratio of less than 6% even to have a minimum dividend payout ratio of 15%.

The thresholds have to be achieved for three consecutive years, including the year of accounting.

While some big NBFCs such as HDFC Ltd and Bajaj Finance Ltd are unlikely to get hit, others may have to either raise capital or bring down their bad loan stockpile. LIC Housing Finance Ltd may have to raise capital to fortify its ratio, while Mahindra and Mahindra Financial Services Ltd may have to bring down its bad loan stockpile, say analysts. Shares of these firms fell around 3% on Thursday.

These proposed norms are a continuation of the regulator’s efforts to plug gaps in its regulation and supervision of NBFCs. The growing importance of NBFCs in financial stability has made the central bank tighten its regulation and supervision of the sector.

Analysts believe the new norms, if implemented in FY21, would increase write-offs of troubled loans by lenders. Writing off troubled loans brings down incremental provisioning and helps conserve capital. It also brings down the proportion of bad loans in the loan book. “NBFCs can manage these ratios by raising tier II capital in case of non-compliance on the former or adjusting write-offs in case of deficit for the latter. NBFCs and HFCs can toggle between NPL provisions and write-offs or increase coverage on GNPLs in order to comply with net NPL requirements," wrote analysts at Kotak Institutional Equities in a note.

While dividends may not be justified in FY21 given the pandemic, RBI’s move ensures that shareholders do not get undue returns at the cost of the business even in good times.

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