Additional Tier-1 Bonds (AT-1 bonds) have been in focus recently after the Reserve Bank of India (RBI) allowed banks to exercise call options on these bonds before the 5-year lock-in period if needed to meet regulatory capital requirements.
Understanding AT-1 Bonds
- Hybrid debt instruments issued by banks to raise capital
- Considered quasi-equity, falling between equity and debt
- Have perpetual tenor with no fixed maturity
- Carry higher risk than traditional bonds
Key Features
- Issued under Basel III norms to enhance bank capital
- Allowed by RBI for bolstering tier-1 capital base
- Have call option allowing issuer to redeem post 5 years
- Higher coupon rates – over 9% currently
- Absorb losses through write downs if bank capital falls below minimum thresholds
Reasons For Being in the Spotlight Now
- Many PSBs nearing end of 5-year lock-in period for bonds issued earlier
- Investor concerns on banks exercising call options prematurely
- Rising interest rates increasing costs for banks
- RBI allowing early redemption to help banks conserve capital
Perspectives on RBI’s Announcement
RBI announced relaxation of norms allowing banks to redeem AT-1 bonds before 5 years. This has garnered mixed reactions:
Supporters Say
- Helps banks cut high interest costs
- Boosts investor confidence in bank-issued capital bonds
- Upholds contract enforcement with disclosure
- Prioritizes sector capital optimization needs
Critics Argue
- Violates investor return expectations
- Disincentivizes retail investments in risky instruments
- Issue of transparency & certainty for investors
- Sets unhealthy precedent diluting trust
Other Recent Developments
- ICRA downgrades AT-1 bonds of Punjab & Sind Bank to junk status
- Bank of India first to announce exercising call option on around ₹3,000 crore AT-1 bonds
- Investors body asks RBI to reconsider & withdraw order on early redemptions
The evolving landscape highlights the multifaceted implications of this complex issue.
Key Stats and Projections
- AT-1 outstanding bonds currently – ₹ 90,000 crores
- PSBs’ average capital adequacy ratio – 14.3%
- Bank credit growth projection 2023-24 – Over 15%
Challenges with AT-1 Bonds
While AT-1 bonds serve capital adequacy needs of banks, certain challenges exist:
Investor Sentiments
- Retail investors suffered losses in past due to write-downs during crisis situations
- Poor transparency on bond health makes assessment difficult
- Reluctance to invest again due to concerns about premature calls
Steps like investor awareness programs needed to rebuild trust.
Threats of Contagion Risks
- Stress in shadow banking feeding into mainstream finance
- Over-reliance on wholesale funds through bonds instead of sticky retail deposits
- Criticism on misselling complex products to investors out of depth
Regulations on quality of market practices important.
Issues in Pricing Practices
- Information asymmetry makes fair valuation difficult
- Rating agencies criticized for inconsistent quality of risk analysis
- Banks accused of misusing investor demand to lower coupon rates
Frameworks on disclosure standards and due diligence required.
Global Perspective
- US Fed banned payments of dividends/buybacks for banks holding AT-1 bonds
- EU brought out strict eligibility criteria for Additional Tier 1 and Tier 2 capital instruments
- UK regulator mandates consumer warnings on risk of loss while marketing
India too needs calibrated governance.
Outlook on AT-1 Bonds
- Banks expected to continue tapping AT-1 bonds to fund credit pick up
- India permits highest volume globally as a % of risk-weighted assets
- RBI supports market-driven pricing aligned to risks
Measures like increasing frequency of surveillance and transparency around disclosures represent progressive way forward balancing financial stability and growth.