In securities markets, dividends more often than not are a signal. Payout dynamics are different for a mature electric utility to that of a young company with a lot of potential for growth. If the right balance is not struck, boards may be rewarding shareholders handsomely now at the cost of growth in the future. With a short, 26-year history of public investing, Nepal is not a mature market and this is evident in the dividend policy of commercial banks in particular.

A company can do three things with its profit—reinvest, retain or pay a dividend. Dividends can be in cash or bonus shares, or a combination of both. Accounting-wise, in the case of a cash dividend, the amount is deducted from retained earnings, decreasing stockholders’ equity. In a stock dividend, the amount is simply transferred from retained earnings to paid-up capital, with no change in stockholders’ equity. Importantly, a stock dividend increases the number of shares outstanding, diluting the book value per share.

Mature companies pay high dividends

Typically, in developed markets, because they have predictable cash flows, mature companies tend to give out a steady dividend. Take a utility or phone company, for instance. Their business does not fluctuate much, in comparison to, say, a consumer discretionary company in retail or housing. During times of market volatility, investors tend to gravitate toward dividend payers for both income and stability. Utilities and consumer staples are even considered bond proxies; sovereign bonds are considered risk-free.

By and large, companies tend to retain profit when they are in growth mode. Microsoft was established in 1975, was profitable when it went public in 1986, but it was not until 2003 it began offering a dividend, starting at $0.08/share annually, which has now grown to $2.04. Amazon, which last year took home $8.3 billion in net income, still does not pay a dividend. The 25-year-old company is still growing at a breakneck pace and obviously sees it fit to reinvest its profit, and it is paying off.

In Nepal, the dynamics are a little different. This is not too surprising given the fairly young history of investing. Nepal Stock Exchange (NEPSE ) only opened its trading floor in January 1994. Bonds do trade, but the market is yet to develop—be it sovereign or corporate. Equities hardly compete with fixed income. Not to draw a comparison with the US, but one of the factors helping equity bulls is that the S&P 500 large market capitalisation (large cap) index currently yields more than the 10-year Treasury yield. In Nepal, such dynamics are lacking. It is thus hard to read too much into public companies’ dividend policy—or a lack thereof.

Yet, it is hard to get one’s arms around the aggressive payout posture shown by Class A commercial banks. To be clear, the payout ratio is also healthy among Class B, C and D financial institutions and several more in other sectors. But commercial banks enjoy a lot of heft in Nepal’s stock market, accounting for 53 percent of NEPSE’s current market capitalisation of Rs1,550 billion. There are 27 of them. Global IME Bank and Janata Bank recently completed their merger. Rastriya Banijya Bank (RBB), which is government-owned, does not trade publicly, while Agricultural Development Bank (ADB) and Nepal Bank—the other two majority-owned by the government do. The remaining 24 are private-sector banks, of which Century Commercial Bank, as of this writing, is the only one yet to announce a dividend for the fiscal year 2018-19 that ended mid-July last year. RBB has never paid a dividend in its history.

Of the 25 that have announced a dividend for the last fiscal year, NIC Asia’s 61 percent payout ratio was the lowest, while NMB Bank took the honour of being the highest, at a whopping 175 percent. Viewed another way, the 25 took home nearly Rs58 billion in profit and doled out nearly Rs46 billion in dividends, consisting of Rs21.3 billion in bonus shares (stock) and Rs24.4 billion in cash. Bonus shares will help retain cash but will negatively impact the earnings per share going forward because shares outstanding will have risen. There is no free lunch. Post-adjustment of bonus shares, the paid-up capital of the 27 banks will have increased to Rs272 billion from Rs251 billion.

This comes at a time when the management at banks are constantly complaining about deposit growth not keeping up with loan demand, which puts upward pressure on rates. As of mid-November, these banks held Rs2,975 billion in deposits, while disbursing Rs2,643 billion in loans. In the grand scheme of things, the Rs24.4 billion doled out in cash dividends may not move the needle much but nevertheless contains an important message. In essence, every rupee that gets paid out is a rupee not reinvested to grow and generate capital gains. This is an important factor to consider given Nepal, still a least developed country, probably has decades of growth ahead before companies hit maturity.

Retain more to invest in the future

That, however, is not the message coming out of the C-suites of these banks. The payout ratio mimics that of companies with stagnant or minimal growth. Not enough is being retained. As of last fiscal year, the 27 banks held Rs50 billion in retained earnings. The boards are either not convinced of growth prospects ahead or something else is driving their decision.

In 2015, while announcing the 2015-16 Monetary Policy, Nepal Rastra Bank (NRB) gave commercial banks two years to raise their paid-up capital from Rs2 billion to Rs8 billion. Banks obliged, but by issuing rights and bonus shares, not through merger, which was NRB’s intended goal.

Viewed this way, promoters, who own at least 51 percent of these banks, arguably have an incentive to get back their investment as soon as possible, hence the generous dividends. However, because they have the biggest stakes in these banks, the ones with a long-term horizon should remember this. An excessively high payout ratio will be hard to sustain, because not enough of the bottom line is getting retained for company growth. Here is one simple statistic. The 27 commercial banks currently operate less than 3,700 branches and offer 3,400 ATMs. It is a nation of 29 million people, with rising living standards. You reap what you sow.

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