RBI tweaks rules to avoid bond coupon defaults by banks

‘Decision avoids potential damage to sentiment in AT1 bond market’

USE OF STATUTORY RESERVES ALLOWED

IN A step aimed at preventing lossmaking banks from defaulting on coupon payments on bonds, the Reserve Bank of India (RBI) has decided to allow them to use their statutory reserves to pay coupons on Basel-iii Additional Tier-i (AT1) instruments.

Analysts said there was a possibility of defaults by some banks on interest payment if they are not allowed to use statutory reserves to pay interest on AT1 bonds. While AT1 bond is a combination of debt and equity, interest on these bonds — raised to boost their capital adequacy ratio — is paid provided banks have adequate profit to service them.

The RBI’S decision, in a circular dated February 2, to allow Indian banks to use their statutory reserves to pay coupons on AT1 instruments avoids any potential damage to sentiment in India’s domestic AT1 market, which would have made it even harder for banks to raise the large amount of new capital that they require over the next two years, according to Fitch Ratings. It also highlights the impact of persistent losses and weak internal capital generation in the sector, which has left some banks lacking distributable reserves and at risk of skipping coupon payments.

Indian banks were previously required to make coupon payments on AT1 instruments from either their profits or from revenue reserves. But the RBI’S push for banks to recognise problem loans has led to a deterioration in profitability and depletion of distributable reserves over the last two years.

By allowing banks to also make AT1 payments from statutory reserves, into which Indian banks place 25 per cent of their profits, the RBI has reduced a potential trigger for skipped payments. “The practice of dipping into statutory reserves for distributions is unusual, but not completely unheard of. For example, national company legislation and individual bank statutes in Italy and Portugal allow for some distributions from statutory reserves. But the decision underlines the pressures that have built in the Indian banking sector,” Fitch said.

Banks will require about $90 bn in new total capital by the financial year ending March 2019 to meet Basel-iii norms, with around 30 per cent of this to be met through AT1 issuance.

Crisil said public sector banks have issued Rs 31,000 crore of AT1 bonds, of which Rs 21,500 crore worth of bonds were issued in the current fiscal.