Recently, the Reserve Bank of India (RBI) has made a proposal to write-down Additional Tier-1 (AT-1) bonds as part of the SBI-led restructuring package for Yes Bank.
The circular was issued by SEBI on March 10, 2021, regarding the AT1 bonds and this will take effect from April 1, 2021.
This has generated significant apprehension in the mutual fund industry for which the losses would result from the consequential revaluation of AT1 bonds.
- AT1 bonds are hybrid products that offer a fixed return that can be reset.
- These bonds are however risky as equities.
- These are unsecured instruments and are complex in nature, the investors are required to read the fine print before they put money in them.
- The bonds do not have fixed maturity. However, the banks which are issuing them can repay them at certain dates. These specified dates are regarded as the maturity dates historically.
There are two routes through which these bonds can be acquired:
- Initial private placement offers of AT-1 bonds by banks seeking to raise money.
- Secondary market buys of already-traded AT-1 bonds.
AT-1 bonds are regulated by RBI. If the RBI feels that a bank needs a rescue, it can simply ask the bank to write off its outstanding AT-1 bonds without consulting its investors.
It is an international regulatory accord that introduced a set of reforms designed to improve the regulation, supervision and risk management within the banking sector, post-2008 financial crisis.
Under the Basel-III norms, banks were asked to maintain a certain minimum level of capital and not lend all the money they receive from deposits.
According to Basel-III norms, banks' regulatory capital is divided into Tier 1 and Tier 2,
while Tier 1 is subdivided into
- Common Equity Tier-1 (CET-1) and
- Additional Tier-1 (AT-1) capital.
Common Equity Tier 1 capital includes equity instruments where returns are linked to the banks’ performance and therefore the performance of the share price. They have no maturity.
Additional Tier-1 capital is perpetual bonds that carry a fixed coupon payable annually from past or present profits of the bank.
They have no maturity, and their dividends can be canceled at any time.
According to the Basel norms, if minimum Tier-1 capital falls below 6%, it allows for a write-off of these bonds.