Why Was There 'No' Bonding Between Govt And Markets Regulator SEBI Over AT-1 bonds?

The additional tier – I (AT-I) bonds are back into the news: and yet again for no good reasons. AT-1 bonds were in news last year as well, after the YES Bank's collapse, which I have detailed in my book – The Banker Who Crushed His Diamonds: The YES Bank Story.

Having covered in detail the shadow banking crisis as a reporter and broken the story on impending insolvency of YES Bank (which later on turned into a book), the Franklin Templeton crisis, and the bad loans in Indian banks, I am of the view that the difference of opinion between Securities Exchange Board of India (SEBI) and government on AT1 bonds needs broader scrutiny.

On March 10, 2021, the markets regulator SEBI came up with a new circular on directives for how mutual fund houses are to allocate funds in their debt schemes. As per this circular, effective on April 1, issuers will have to treat the AT-1 bonds as having 100-year maturity. Also, the regulator capped the mutual fund exposure to a single issuer of these AT-1 bonds to 5% with respect to fresh issuances and at the individual scheme level, no fund shall be holding more than 10% of its Net asset value (NAV) of the debt portfolio in such instruments.

Department of Financial Services, a part of the Union Finance Ministry, requested the SEBI to withdraw this. The government's contention was that it will cause volatility in the pricing of debt funds.

Also, the government objected to this stating that it will curb the credit lines for the Public Sector Unit (PSU) Banks. It is pertinent to note that, PSU Banks may be scouting for fresh capital, as huge waves of bad loans are likely to hit Indian Banking soon. In its Financial Stability Report, the banking regulator, the Reserve Bank of India (RBI) expects the ratio of gross bad loans to gross advances to double by September 2021. To write off such loans, the banks would need more money. However, with rising income shortfall for the government, the recapitalization of banks is out of the question, and that is where AT-1 bonds can come into the picture.

Ultimately, on Monday, March 22, the SEBI partially eased these norms. It said the maturity would be 10 years until March 31, 2022, and would be increased to 20 and 30 years over the subsequent six-month period. And from April 2023 onwards, the residual maturity of AT1 bonds will become 100 years from the date of issuance of the bond.

So, what are AT-1 bonds?

After many bulge bracket banks collapsed in the global financial crisis due to the paucity of funds, the apex banks across the world increased the focus on the capital adequacy of the banks. In India, the banks need to have mandated capital at a minimum ratio of 11.5% of their risk-weighted loans. Of this, 9.5% needs to be in Tier-1 capital (equity and permanent capital) and 2% in Tier-2. As unsecured, perpetual bonds, banks issue AT-1 bonds to shore up their core capital base, and hence the Tier-1 capital.

What happened last year?

As part of YES Bank's bailout package, the AT-1 bonds were written off, which is talked about in my book:

Also, according to the initial scheme, AT1 bonds of YES Bank, worth Rs 8415 crore, were written off completely, for which bondholders went to court. AT1 bonds are issued by banks to shore up capital and are a form of debt capital. These bonds are perpetual in nature and pay high coupons or interest rates.

However, the final scheme was silent on their status, but the bank's interpretation of their legal status brought the write-down into effect, causing many retail investors to lose money. Some of these investors were retired individuals who had parked a sizeable chunk of their life savings in these bonds at the behest of relationship managers from the bank in 2017. The case in this regard is ongoing in the Bombay High Court.

As these bonds are perpetual in nature, if mutual funds invest funds garnered in schemes that are meant for the short and medium-term, it would cause an asset-liability mismatch in the schemes. In the past two years, asset-liability mismatch (ALM) led to the shadow banking crisis in India.

If we look at the allocation of Franklin Templeton's six schemes that have been wound up, we can see a clear cut ALM as well. In the six high risk-high yield schemes that were wound up, redemptions happen in less than a year. But take the case of Franklin India Credit Risk fund: at the time of winding up the fund, 27% of its portfolio was stuck in the bonds with a maturity date in a range of 5-11 years later – a clear-cut case of asset-liability mismatch.

While, I have criticized the regulators for inaction many times, including in my book The Banker Who Crushed His Diamonds, yet I would have to say, SEBI is trying to fix some loopholes in the system and the government should find alternative ways of raising capital for the banks, rather than causing hindrance by way of such 'requests'. Probably it is time for the government to divest some stake in PSU Banks to help them raise funds?

(The writer is a senior banking journalist and an author of The Banker Who Crushed His Diamonds)

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