Basel III Capital: Dividend Plan Breaches the Capital Conservation Buffer
Meridian Bank reports CET1 capital of ₹1,080 crore, AT1 of ₹120 crore and Tier 2 of ₹240 crore against RWA of ₹12,000 crore. It plans to grow RWA by ₹1,800 crore next quarter and pay an equity dividend of ₹100 crore from current-year profit. The board also proposes issuing ₹150 crore of AT1 to replace maturing Tier 2. India’s Basel III minima are CET1 5.5%, Tier 1 7%, total capital 9%, plus a capital conservation buffer (CCB) of 2.5% in CET1. The bank is not under PCA. The CFO argues that because current CET1 is 9%, the dividend is safe. The risk head warns that the plan may breach the CCB and attract dividend restrictions. No countercyclical buffer is applicable.
1. Compute current ratios, post-growth ratios and post-dividend ratios. Check compliance against the minima including the CCB. Assume the AT1 issue replaces the maturing Tier 2.
Read the worked answer
Current ratios:
- CET1 = 1,080 / 12,000 = 9.00%
- Tier 1 = (1,080 + 120) / 12,000 = 10.00%
- Total capital = (1,080 + 120 + 240) / 12,000 = 12.00%
Requirements including CCB are CET1 5.5 + 2.5 = 8.0%, Tier 1 7 + 2.5 = 9.5%, and total capital 9 + 2.5 = 11.5%. The bank is currently compliant.
After RWA grows to ₹13,800 crore and the ₹100 crore dividend is paid, CET1 becomes 980 crore:
- CET1 = 980 / 13,800 = 7.10%
- Tier 1 after AT1 substitution = (980 + 270) / 13,800 = 9.06%
- Total capital = (980 + 270 + 90) / 13,800 = 9.71%
All three measures are below the incl-CCB requirements. CET1 is below 8.0% by 0.90% of RWA, or about ₹124 crore. Tier 1 is below 9.5% and total capital is below 11.5%. The AT1 issue helps Tier 1 but does nothing for CET1, and total capital is unchanged because AT1 replaces Tier 2.
2. Can the bank pay the proposed dividend? What should the board do instead?
Read the worked answer
The CFO’s 9% current CET1 figure is the wrong comparison. The relevant CET1 requirement is 8.0% including the CCB, and after planned growth and the dividend the bank falls to 7.10%. A CET1 ratio between 5.5% and 8.0% means the bank is eating into its CCB. Under the Basel capital conservation framework, distributions are subject to minimum conservation and payout restrictions; the board cannot assume an unrestricted ₹100 crore dividend.
The board should cut or defer the dividend, retain earnings, and restore CET1 before making distributions. Options include:
- a rights issue or qualified institutional placement to raise CET1;
- slowing RWA growth or repricing low-return assets;
- selling non-core assets to generate CET1;
- issuing AT1 only to support Tier 1, not as a substitute for CET1;
- reducing the dividend to a level that keeps CET1 at or above 8.0% after growth.
A useful test is to work backwards: at ₹13,800 crore RWA, 8.0% CET1 requires ₹1,104 crore. Current CET1 is ₹1,080 crore before the dividend, so even without the dividend the bank is short by about ₹24 crore. The dividend therefore cannot be paid in full without new CET1.