What do bank dividends tell us?
Bankers, regulators, investors have a different take on dividend policy
By Kang Ye-won
Since the global financial crisis and the Occupy Wall Street protest movement, banks have been pressured to run their business more conservatively and one way they have done this — sometimes under duress — is to slash dividends to investors. Korean banks, too, have lowered their dividends, due to toughened government regulations, and beefed up capital reserve requirements to hedge against global uncertainties.
Banks claim that such government influence hurts their business growth, whereas financial regulators emphasize stability at banks as opposed to other corporations.
Usually banks decide how much to of their earnings to give back to shareholders as dividends, the so-called dividend ratio, based on many factors including capital gains, potential growth, relationship with the holding company and dividend tax. The average payout ratio of Korean banks over the past eight years was about 20 percent, according to Suh Byung-ho, a research fellow at the Korea Institute of Finance (KIF), in a research note.
And bankers claim that it’s too low to appeal to their shareholders.
“In order for a bank to keep its leverage, the dividend ratio should be about 50 percent,” said a banking analyst who asked for anonymity. The leverage ratio indicates how much banks can increase return on investment. Korean banks used to hit around a 20 percent leverage ratio but nowadays it’s dropped to about 13 percent, the source said.
“We have a responsibility to satisfy all different interest groups, ranging from our customers to shareholders to regulators to the community. It’s important for us to balance serving the needs of each group,” the source said.
But others disagree saying that banks have to prioritize their obligations.
“A bank’s real function is not to reward shareholders but to work with everyday customers like Mrs. Lee and Mrs. Park, and help them put their money somewhere safe,” said James Rooney, chief executive of Market Force Company, based in Seoul.
In other words, a bank’s number one responsibility is safe capital management and then it should concentrate on business growth.
As an investor who believes in no dividends, Rooney said, when companies give them out or buyback shares, it’s a signal that they have failed to expand their businesses. Investors who seek for regular income from their investment should rather buy government bonds or go into real estate, he added.
Critics have also argued that foreign bank subsidiaries in Korea, compared with local ones, inflated their payouts, which encourages an “eat-and-run investment practice” among foreign investors.
The three foreign-owned banks — Standard Chartered Bank Korea, Citibank and Korea Exchange Bank before the takeover by Hana Financial Group — recorded nearly a 56 percent dividend ratio on average in 2010, compared with local banks’ rate of about 33 percent, according to Suh with KIF.
Local banks included KB, Woori Bank and Shinhan Bank, in Suh’s study. Overall, this was a big jump from the financial crisis period when banks paid less than 6 percent on average.
Those foreign subsidiary banks gave counter-arguments that the practice of high dividends indicates a healthy book value of the banks.
“Criticizing dividend yield is a one-dimensional approach,” said Chung Han-young, a media manager at Standard Chartered Bank Korea.
“Since we started to give out dividends in 2009, we have always focused on capital gains and considering our track record, we made the (dividend payout) decision accordingly,”
Compared to international figures, Korean banks still paid dividends at a relatively lower rate with an average of 21 percent. The U.S. and U.K. banks recorded up to 70 percent and 50 percent on average, respectively, in the past five years. Japanese banks, on the other hand, were more conservative in paying at roughly 19 percent. However, this is not an apple-to-apple comparison considering different sizes and the financial soundness of the banks, Suh added.
Korean banks have had high volatility in the past and traditionally the government stepped in for most financial crises whether it was the Asian financial crisis in 1997-98 or the credit card bubble in 2003, said Choi Young-il, a senior credit officer at Moody’s rating agency.
Also at the outbreak of the financial crisis in 2008, with foreign investors retreating and liquidating Korean assets, Korean stock markets and the won tumbled. Banks here found it almost impossible to raise U.S. dollars to pay maturing foreign-currency loans, and the government stepped in injecting $30 billion to support the banking system, according to a country report by Bertelsmann Stiftung, a non-profit think tank of Bertelsmann, a German media giant.
“Considering how the Korean banking system easily gets shaken by the external uncertainties and with the eurozone crisis still lingering, we see that financial regulators’ pressing banks for stability is not a bad idea,” Choi said.
The regulators agreed that banks should take macroprudential measures bearing global risks in mind.
It’s natural for emerging banks to focus on growth and acknowledge shareholders’ demand by lifting dividends or raising their stock price with share buybacks, said Kim Jung-ryul, a senior manager at the Financial Supervisory Service.
But considering Korean banks’ susceptibility to external factors and the fact that Basel III rules will start to be applied from 2015, “it never hurts to keep extra cash stacked away rather than let it flow out,” Kim said.
Basel III will take effect gradually until the beginning of 2019 requiring banks to increase their capital buffers and limit risky leveraging practices.