Capital raising via Basel-III bonds to become cheaper

The Reserve Bank of India’s move to ease rules for banks to raise capital through debt conforming to Basel-III rules is expected to reduce the cost of doing so by 75-100 basis points (bps).

And, to attract more international investors for bank capital offerings. Accordingly, banks are back with capital raising plans and look for an opportune time to tap the markets, said senior executives.

An IDBI Bank employees said banks had been waiting for clarity. “Now, we will evaluate our capital raising through additional tier-I bonds. We might use Basel-III compliant bonds to raise $500-600 million. The preference will be for international markets,” the official indicated.

Pawan Agarwal, senior director at CRISIL Ratings, said these amendments would reduce the risk element for investors. So, the risk premium on such instruments is expected to come down. Also, more classes of investors will be interested in debt. The coupon or interest paid on bonds compliant with Basel-III will come down by 75-100 bps, he added.

RBI has diluted a few guidelines under its revised Basel-III guidelines. The loss absorption mechanism of additional tier-I and tier-II instruments has been revised to temporary or permanent, compared to only permanent earlier. Also, rules on core equity, a significant driver of the limits of recognising AT-1 or AT-2 instruments, have been relaxed. Banks will also be allowed to include a counter-cyclical buffer and capital-conservation buffer during the period of utilisation.

Exercising of call options has been relaxed to five years from 10 years earlier. The original period of maturity of tier-II instruments has been relaxed to five years from 10 years earlier.

Retail investors would be allowed to participate in AT-1 instruments. This comes with a rider that these small investors are made aware about the risks associated with the instruments and to ensure they understand it.

Finally, banks would be allowed to dip into revenue reserves to pay out interest but subject to certain conditions. Earlier, they could use only the current year's earning to service coupon payment obligations.
POSITIVE FALLOUT OF RBI’S MOVE

• Expected to reduce loss given default. Therefore may improve investor appetite
• Reduce probability of banks’ missing coupon payment on instruments
• Could help widen investor base for banks’ AT1 capital instruments
• Investors with relatively short investment horizon could also invest
• As equity (CET1) is expected to be costlier, banks may opt to maintain excess AT-1 and Tier-II capital for higher capital adequacy

Source: Icra