Commentary: Valid reasons for MAS’ call to cap dividends

Date: August 17, 2020

First published in Straits Times on 17 August 2020

Pre-emptive, prudent move ensures vital banking sector remains resilient, able to support lending amid virus crisis

The Monetary Authority of Singapore (MAS) recently instructed local banks and finance companies to cap their total dividends per share for the 2020 financial year at 60 per cent of total dividends paid last year, and offer investors the option of receiving payouts in shares, not cash.

The move led to some raised eyebrows, primarily because the regulator has never before interfered in dividend policies, which are usually left to the discretion of directors.

For example, a letter in The Straits Times on Aug 10 argued that many investors rely on dividends to help pay loans and mortgages.

Indeed, it is likely that investors who rely on dividends as an important source of passive income would be the most unhappy with the move, especially with payouts by most real estate investment trusts, or Reits, already having been severely cut because of Covid-19.

Moreover, some might argue that Singapore banks are well-capitalised and have sufficient reserves to withstand most shocks – in fact, the MAS said as much in its July 29 statement.

“MAS stress tests have shown that the local banks remain resilient even under adverse conditions consistent with a serious and prolonged public health crisis,” it said.

The most common ratio to assess a bank’s financial strength is the Common Equity Tier 1 (CET1), which measures CET1 capital against risk-weighted assets. The ratio was adopted after the 2008 financial crisis with a minimum requirement ratio of 4.5 per cent.

Since the ratio measures a bank’s coverage of its risky assets, the higher the number, the stronger its finances.

Although the MAS requires that banks here have a minimum CET1 ratio of 6.5 per cent, the ratios of DBS Bank, OCBC Bank and United Overseas Bank have been estimated to be at least twice this figure, which, to begin with, is higher than the global requirement.

Critics of the regulator’s move argue that since Singapore banks are so much stronger than what regulations require, then surely it might be better to just leave individual banks to decide on how much they want to pay shareholders?

While this is a valid question and while shareholders, particularly retirees, who rely on dividends to supplement their incomes, can justifiably feel upset at the prospect of reduced payouts, there are valid reasons for the MAS’ move.

IN SYNC WITH GLOBAL MOVES

Before going further, it is worth bearing in mind that banks and finance companies are required to comply with the rules and regulations issued by the MAS.

In other words, investors must be cognisant of potential regulatory changes or supervisory directions when buying shares in financial institutions.

However, regulatory risk does not usually surface as a major factor in normal circumstances.

First is that it is in line with similar moves across the world and, as a key financial centre, Singapore is not out of sync with practices set by other major central banks.

The European Central Bank, for example, on July 28 asked banks under its supervision not to pay dividends or perform any share buybacks until January next year.

It said the instruction “is aimed at preserving banks’ capacity to absorb losses and support the economy in this environment of exceptional uncertainty”, adding that the uncertainty makes it difficult for banks to accurately forecast their capital positions.

In April, the Reserve Bank of New Zealand ordered banks to stop paying dividends or redeeming capital notes, saying the order “supports the stability of the financial system by maintaining higher levels of capital during the period of falling economic activity resulting from the Covid-19 pandemic”.

The Australian Prudential Regulation Authority (Apra) said in April that it expected “prudent reductions in dividends” paid by banks during the crisis. Last month, it updated this to say banks “do not need to continue to defer capital distributions, provided they moderate payments to sustainable levels based on robust stress testing and continue to prioritise supporting customers and the economy”.

Apra said dividend payout ratios for banks should be below 50 per cent for this year.

The Bank of England’s Prudential Regulation Authority in April urged the country’s commercial banks to preserve capital to help the economy and not pay dividends.

“Although the decisions taken today will result in shareholders not receiving dividends, they are a sensible precautionary step given the… economic disruption,” it said.

Second and more important, although more examples from around the world can be presented, the message should already be clear from the common thread: The devastation wreaked by Covid-19 is extensive and could have massive consequences on the financial system and the economy.

Seen in this light, the MAS instruction is a pre-emptive, prudent move to ensure that the vital banking sector remains resilient and retains its capacity to support lending to businesses and individuals during a massive crisis of unknown tenure.

It is also relevant to note that the MAS is paying close attention to what could happen at the end of the year when relief measures introduced to ease the burden on households and businesses expire.

For example, home mortgage borrowers can defer repayments until December, which lifts pressure on their immediate cash flow.

However, if the situation does not improve by then – and there is little reason to think it will – what would be the impact on banks if those who opt for this deferment are unable to resume their repayments?

MAS managing director Ravi Menon said last month that the regulator is looking at ways to ease borrowers into resuming payments because relief cannot continue forever.

The results of its study are due in October and should provide some clues on what lies ahead for banks.

In the meantime, because the three Singapore banks are well-capitalised and well-managed, their long-term outlook remains positive, but they should engage stakeholders during this difficult period to maintain investor confidence.

Shareholders may therefore wish to consider the scrip dividend option instead of cash for this year.

For those prepared to hold their investments for many years, receiving more shares today could mean more capital gains tomorrow, which could make up for dividends sacrificed in the interim.

• The writer is David Gerald, founder, president and CEO of the Securities Investors Association (Singapore)