Indian Banks Will Have Easier Time Issuing Basel III Instruments with New Rules, a Credit Positive

Srikanth Vadlamani, Vice President - Senior Analyst, Financial Institutions Group, Moody's Investors

On 1 September, the Reserve Bank of India (RBI), the country's central bank, revised some of its rules governing instruments that qualify as bank capital under Basel III. The new norms are credit positive for Indian banks, in particular public-sector banks, because they will make the instruments more attractive to investors, broaden the investor base for additional Tier 1 (AT1) securities to include retail investors and allow banks to have a higher proportion of AT1 capital in their Tier 1 capital.

Several changes will make AT1 instruments more attractive to investors. Writedowns of principal when a bank's common equity Tier 1 (CET1) capital breaches the trigger level can now be temporary, giving investors the possibility of recouping their losses if the health of the bank improves. From 2019, Indian banks' CET1 trigger point for loss absorption will be 6.125%, compared to the BCBS recommendation of 5.125%. With the option of a temporary writedown now incorporated, RBI may be looking to partially mitigate investor concerns about this relatively high trigger. Banks are also no longer required to pay all coupons out of current-year profits, but may now also use revenue reserves, which are non-earmarked reserves, and/or credit balances in the profit and loss account. In addition, the minimum period after which banks can exercise a call option to repurchase AT1 instruments has been shortened to five years from 10 years, as has the minimum maturity at issuance for Tier 2 instruments, providing issuing banks with more flexibility.

Another issue that discourages Indian banks from issuing these instruments (so far only the Bank of India has issued an AT1 instrument) is the lack of a broad domestic investor base. RBI has tried to address this by widening the investor base to include retail investors. The other key change in the new rules is the removal of certain limits on the amount of AT1 that a bank can use for calculating its Tier 1 capital, which effectively limited AT1 issuance to 1.5% of risk-weighted assets. At a time when public-sector banks are finding it difficult to raise equity capital from the public markets, this provides a way for banks to bolster their Tier 1 ratio by raising a higher amount of AT1 capital.

Low capital levels are a key credit weakness for many Indian banks, particularly public-sector banks.

Measures that make it easier for banks to sell AT1 instruments to investors, and make it easier for banks to use AT1 instruments in meeting capital requirements, should help them improve their Tier 1 ratios.

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