Topics Covered: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.
What are Additional Tier-1 bonds?
Context:
Securities and Exchange Board of India has tightened its regulations of additional tier-1 bonds or AT-1 bonds and ensured that these risky instruments are less accessible to retail investors.
Changes introduced:
- Banks can issue these bonds only on electronic platform.
- Only institutional investors could subscribe to them.
- There shall be a minimum allotment size and trading lot size of ₹1 crore.
(An institutional investor is a company or organization that invests money on behalf of other people. Mutual funds, pensions, and insurance companies are examples.)
Basics:
What are Additional Tier-1 bonds?
Under the Basel III framework, banks’ regulatory capital is divided into Tier 1 and Tier 2 capital.
- Tier 1 capital is subdivided into Common Equity (CET) and Additional Capital (AT1).
AT1 bonds are a type of unsecured, perpetual bonds that banks issue to shore up their core capital base to meet the Basel-III norms.
Key features:
- These have higher rates than tier II bonds.
- These bonds have no maturity date.
- The issuing bank has the option to call back the bonds or repay the principal after a specified period of time.
- The attraction for investors is higher yield than secured bonds issued by the same entity.
- Individual investors too can hold these bonds, but mostly high net worth individuals (HNIs) opt for such higher risk, higher yield investments.
- Given the higher risk, the rating for these bonds is one to four notches lower than the secured bond series of the same bank.
However, it has a two-fold risk:
- First, the issuing bank has the discretion to skip coupon payment. Under normal circumstances it can pay from profits or revenue reserves in case of losses for the period when the interest needs to be paid.
- Second, the bank has to maintain a common equity tier I ratio of 5.5%, failing which the bonds can get written down. In some cases there could be a clause to convert into equity as well.
Given these characteristics, AT1 bonds are also referred to as quasi-equity.
Differences between Common Equity (CET) and Additional Capital (AT1):
Equity and preference capital is classified as CET and perpetual bonds are classified as AT1.
- By nature, CET is the equity capital of the bank, where returns are linked to the banks’ performance and therefore the performance of the share price.
- However, AT1 bonds are in the nature of debt instruments, which carry a fixed coupon payable annually from past or present profits of the bank.
InstaLinks:
Prelims Link:
- Basel Norms 1 vs 2 vs 3.
- CET vs AT1.
- Tier 1 vs 2 capital.
- ‘Point of Non-Viability Trigger’ (PONV).
- Role of RBI during bank crisis.
Mains Link:
Write a note on Basel norms.
Sources: the Hindu.
