The government of India recently undertook a financial innovation by issuing Rs. 5,500 crore worth Special Zero Coupon Recapitalisation Bonds to recapitalise Punjab & Sind Bank. The public sector bank is essentially an Indian Government undertaking.
Understanding Bank Recapitalisation
Bank Recapitalisation refers to the act of infusing additional capital into state-run banks to ensure they meet capital adequacy norms. Specifically, Indian public sector banks are necessitated to maintain a Capital Adequacy Ratio (CAR) of 12%. This ratio represents a bank’s capital in proportion to its risk-weighted assets and current liabilities.
Different instruments are used by the Government to infuse capital into banks facing a capital shortage. Since the government acts as the chief shareholder in public sector banks, it is their responsibility to fortify banks’ capital reserves. The government fundamentally does this by buying new shares or issuing bonds.
The Rationale Behind Recapitalisation
Recapitalisation is implemented in line with the guidelines of Reserve Bank of India (RBI). Based on Basel norms, these guidelines necessitate banks to maintain certain amounts of capital reserves.
Nature of Recapitalisation Bonds
In the scenario of recapitalisation bonds, the government issues the bonds, which are then subscribed to by banks. The collected money goes to banks in the form of equity capital, as the government augments its share of equity holding, thus boosting the banks’ capital reserves.
Banks invest their money in these bonds, which are categorised as an investment earning them interest. This process aids the government in maintaining its fiscal deficit target since no direct money is withdrawn from its coffers.
Features of Special Zero Coupon Recapitalisation Bonds
Special Zero Coupon Recapitalisation Bonds are unique types of bonds issued by the Central government to a particular institution exclusively. Only specified banks can invest in these bonds, and they are not transferable nor tradable. Issued at par, they offer zero coupon and are paid at the end of the stipulated period. The bond is held in the Held-To-Maturity (HTM) category in accordance with RBI guidelines.
Role of Financial Innovation
The issuance of these special bonds marks financial innovation since it does not affect the fiscal deficit but still manages to provide much needed equity capital to the bank.
Differences Between Regular Zero Coupon Bonds and Special Zero Coupon Bonds
A regular Zero Coupon Bond is bought at a discounted price and does not pay any coupons or periodic interests to the fundholders. The investor’s return is indicated by the difference between the purchase price of a zero-coupon bond and the par value at the time of maturity.
Contrarily, Special Zero Coupon Bonds are issued at par and do not yield interest. However, normal Zero Coupon Bonds come at a discount and thus technically yield interest.
About Bonds
A bond represents a fixed-income instrument indicative of a loan made by an investor to a borrower. Essentially a contract between the investor and borrower, a bond can be issued by companies and Governments. Investors usually buy these bonds as a savings and security option. Upon reaching maturity date, the issuing entity is required to repay the amount to the investor along with part of the profit.
Last Modified: February 9, 2024