The State Bank of India (SBI) has recently drawn attention to itself by raising Rs. 4,000 crore of Basel compliant Additional Tier 1 (AT1) bonds at a coupon rate of 7.72%. This move is considered a first in the domestic market post the new SEBI regulations and it also marks the lowest pricing ever on such debt issued by any Indian bank since the initiation of Basel III capital rules in 2013.
Understanding Bonds
Bonds are essentially units of corporate debt that companies issue and then securitize as tradable assets. Traditionally, bonds pay a fixed interest rate, also known as a coupon, to debtholders, although variable or floating interest rates have now become common. The price of bonds correlates inversely with interest rates; when rates rise up, bond prices fall and vice-versa. Each bond has a maturity date at which point the principal amount is due to be repaid fully to avoid risk of default.
Defining AT1 Bonds
AT1 bonds, also referred to as perpetual bonds, present an interesting dynamic since they carry no maturity date but do have a call option. Should the issuer of such bonds find themselves getting money at a cheaper rate, particularly during falling interest rates, the bonds may be called or redeemed. Banks often issue these types of bonds to boost their core capital base to meet the Basel-III norms. Investors cannot return these bonds to the issuing bank but rather must sell them on secondary markets if they need money.
Regulations of AT1 Bonds
The Reserve Bank of India (RBI) regulates AT1 bonds. If the RBI deems a bank needs rescuing, it can order the bank to write off its outstanding AT1 bonds, without needing consultation with investors.
Basel III Norms
In response to the 2008 financial crisis, an international regulatory accord known as the Basel III norms was established. These reforms aim to improve regulation, supervision and risk management within the banking sector. Under these norms, banks are required to maintain a certain minimum level of capital instead of lending all the money they receive from deposits. The banks’ regulatory capital is divided into Tier 1 and Tier 2 capital. Tier 1 is subcategorized further into Common Equity Tier-1 (CET-1) and Additional Tier-1 (AT-1) capital. As per Basel norms, if a bank’s minimum Tier-1 capital falls below 6%, these bonds can be written off.
Significance of CET and AT-1
Common Equity Tier 1 capital includes equity instruments where returns are linked to the banks’ performance and therefore the performance of the share price. These components have no maturity and together, CET and AT-1 are considered Common Equity under Basel III norms.
Tier 2 Capital
Tier 2 capital consists of unsecured subordinated debt with an original maturity of at least five years. The Basel III norms outline the minimum requirement for Common Equity Capital.