RBI may red-flag Punjab and Sind Bank's Rs 5,500-crore zero-coupon bonds

Bank could be asked to hold it at discounted value in HTM

The Reserve Bank of India (RBI) may red-flag the Rs 5,500-crore zero-coupon bonds issued towards recapitalising (recap) Punjab and Sind Bank (P&SB) in its current form, and ask it to hold the instrument in the held-to-maturity (HTM) portfolio at a discount and not at face value.

“This (structure) has to be reworked. It is bad accounting, and has implications for the broader debt market. You can’t create equity out of thin air,” said a top source.

“It can be abused as an instrument if such accounting norms are allowed,” said another source.

It was, however, pointed that while zero-coupon bonds per se towards bank recap – a novel idea – is not a problem, it is the accounting treatment that has created opposition to the idea. And to that extent, the Centre may have to rethink its fiscal maths if it is to use the instrument for recap.

In recap, the Centre subscribes to a state-run bank’s preferential capital, and the proceeds are invested by the bank in interest-bearing bonds in a cash-neutral transaction and the entries are matched.

In the specific case of P&SB – according to the government’s gazette notification of December 11, 2020 – the Centre issued zero-coupon bonds in a departure from the hitherto interest-bearing recap bonds.

The move would have helped ease the pressure on the fisc of having to service annual interest.

Five non-interest-bearing securities maturing on December 14 between 2030 and 2035 were issued to P&SB. The nature of these instruments is such that the bank gets to have Rs 5,500 crore only on their maturity – or on bullet-redemption.

“The bank has to show the investments at a discount, not at Rs 5,550 crore. And therefore, you also can’t state that the equity infused into the bank is Rs 5,500 crore as the entries have to match,” said a top source.

Recapitalisation bonds issued to date have been interesting-bearing securities and while the central bank had allowed banks (which were recapitalised) to hold them in the held-to-maturity category, the true value of the investments could be ascertained from government securities (G-Secs) of like profiles. Not in the case of zero-coupon bonds. Furthermore, in P&SB’s case the discount on the zero-coupon bonds has to factor in their illiquidity as well.

Incidentally, the “Report on Trend and Progress of Banking in India (2019-20)”, released on Tuesday, observed that “preliminary estimates suggested that potential recapitalisation requirements for meeting regulatory purposes as well as for growth capital may be to the extent of 150 basis points of the common equity tier-I ratio for the banking system. And hints that the headroom for recap may be limited. “While the government has earmarked Rs 20,000 crore in the first supplementary demands for grants for capital infusion, they may raise more resources from the market as an optimal capital raising strategy”, the report said.