RBI issues guidelines for dividend declaration by NBFCs – Links it to capital and NPA norms

The Reserve Bank of India (RBI) on June 24, 2021 has issued guidelines for distribution of dividends by non-banking financial companies (NBFCs) from the profits of financial year (FY) ending March 31, 2022 and onwards.

These guidelines shall be applicable to all NBFCs regulated by the RBI.

Board Oversight

While considering a dividend proposal, the Board of Directors of NBFCs (BoD) has to take into account supervisory findings of the RBI and National Housing Bank (NHB) for Housing Finance Companies (HFCs) on divergence in classification and provisioning for non-performing assets (NPAs). The BoD shall also take into account any qualification in the auditor’s report to the financial statements, and the long-term growth plans of such NBFC.

RBI has mandated the BoD to ensure that the total dividend payout in a FY does not exceed the ceilings prescribed under these guidelines.

Prudential Norm

The RBI has linked declaration of dividend by NBFCs to certain minimum prudential norms on capital and bad loans. Guidelines prescribe the following requirements:

# Parameter Requirement
1. Capital Adequacy a.     NBFCs (other than Standalone Primary Dealers[1] (SPDs)) should have met the applicable regulatory capital requirements[2] for each of last 3 financial years;

b.     SPDs should have maintained a minimum CRAR[3] of 20 percent for the financial year for which dividend is being proposed.

2. Net NPA Net NPA ratio to be less than 6 percent in each of the last three FYs, including at the close of the FY for which dividend is proposed to be declared.
3. Other criteria a.     NBFCs to maintain the Reserve Fund[4] in accordance with the RBI Act, 1934, and other applicable RBI regulations / guidelines;

b.     HFCs to maintain the Reserve Fund[5] in accordance with the NHB Act, 1987;

c.      RBI and NHB (for HFCs) should not have prescribed any other explicit restrictions on declaration of dividends.

Dividend Payout Ratio (DPR)

DPR is the ratio between the amount of the dividend payable in a FY and the net profit as per the audited financial statements for FY for which the dividend is proposed. Proposed dividend to include dividend on equity shares and compulsorily convertible preference shares eligible for inclusion in Tier 1 Capital[6].

In case the net profit for the relevant FY indicates an overstatement[7] of net profit, the same shall be reduced from net profits while determining the DPR.

RBI has prescribed following overall ceilings on DPR:

# NBFCs Maximum DPR (percentage)
1. NBFC not accepting public funds and not having any customer interface No ceiling
2. Core Investment Company 60
3. SPDs 60
4. Other NBFCs 50

Further, NBFCs (other than SPDs), which do not meet the prescribed Prudential Norms, may declare dividend up to 10 percent DPR, provided that it meets the capital adequacy requirement for the FY for which dividend is being declared, and has less than 4 percent NPA.

Also, for SPDs, which have CRAR between 15 to 20 percent, the DPR shall not exceed 33.3 percent.

Reporting Requirements

Details of declared dividend to be reported to RBI within a fortnight of such declaration.

[1] In 1995, the RBI introduced the system of Primary Dealers (PDs) in the Government Securities Market, which comprised independent entities undertaking PD activity. In order to broad base the PD system, banks were permitted to undertake PD business departmentally in 2006-07. Further, the standalone PDs were permitted to diversify into business activities, other than the core PD business, in 2006-07, subject to certain conditions.

[2] Capital requirements applicable to different categories of NBFCs as on June 24, 2021.

[3] Capital to Risk-Weighted Assets Ratio is the ratio of a bank’s capital to its risk. In April 1992, RBI introduced a CRAR system for banks (including foreign banks) in India as a capital adequacy measure in line with the Capital Adequacy Norms prescribed by Basel Committee.

[4] Section 45IC of the RBI Act, 1934

[5] Section 29C of the NHB Act, 1987

[6] Tier I Capital includes (a) paid-up capital (ordinary shares), statutory reserves, and other disclosed free reserves, if any; (b) perpetual non-cumulative preference shares (PNCPS); innovative perpetual debt instruments; and capital reserves representing surplus arising out of sale proceeds of assets.

[7] includes any exceptional and/or extra-ordinary profits/ income or the financial statements are qualified (including ’emphasis of matter’) by the statutory auditor that indicates an overstatement of net profit.

Contributed by Manish Parmar. Manish can be reached at manish.parmar@aureuslaw.com.