Additional Tier 1 Bonds

• 03 Sep 2021

Why in News

Recently, State Bank of India (SBI) has raised Rs. 4,000 crore of the Basel compliant Additional Tier 1 (AT1) bonds at coupon rate of 7.72%.

• This is the first AT1 Bond issuance in the domestic market post the new SEBI regulations.
• This is also the lowest pricing ever offered on such debt issued by any Indian bank since the implementation of Basel III capital rules in 2013.

Bonds

• Bonds are units of corporate debt issued by companies and securitized as tradable assets.
• A bond is referred to as a fixed-income instrument since bonds traditionally paid a fixed interest rate (coupon) to debtholders. Variable or floating interest rates are also now quite common.
• Bond prices are inversely correlated with interest rates: when rates go up, bond prices fall and vice-versa.
• They have maturity dates at which point the principal amount must be paid back in full or risk default.

Key Points

• About:
  
  • AT1 bonds, also called perpetual bonds, carry no maturity date but have a call option. The issuer of such bonds may call or redeem the bonds if it is getting money at a cheaper rate, especially when interest rates are falling.
    
    • They are like any other bonds issued by banks and companies, but pay a slightly higher rate of interest compared to other bonds.
  • Banks issue these bonds to shore up their core capital base to meet the Basel-III norms.
  • These bonds are also listed and traded on the exchanges. So, if an AT-1 bondholder needs money, he can sell it in the secondary market.
  • Investors cannot return these bonds to the issuing bank and get the money. i.e there is no put option available to its holders.
  • Banks issuing AT-1 bonds can skip interest payouts for a particular year or even reduce the bonds’ face value.
• Regulated By:
  
  • AT-1 bonds are regulated by the Reserve Bank of India (RBI). If the RBI feels that a bank needs a rescue, it can simply ask the bank to write off its outstanding AT-1 bonds without consulting its investors.

Basel III Norms

• It is an international regulatory accord that introduced a set of reforms designed to improve the regulation, supervision and risk management within the banking sector, post 2008 financial crisis.
• Under the Basel-III norms, banks were asked to maintain a certain minimum level of capital and not lend all the money they receive from deposits.
• According to Basel-III norms, banks' regulatory capital is divided into Tier 1 and Tier 2, while Tier 1 is subdivided into Common Equity Tier-1 (CET-1) and Additional Tier-1 (AT-1) capital.
  
  • Common Equity Tier 1 capital includes equity instruments where returns are linked to the banks’ performance and therefore the performance of the share price. They have no maturity.
  • Together, CET and AT-1 are called Common Equity. Under Basel III norms, minimum requirement for Common Equity Capital has been defined.
• Tier 2 capital consists of unsecured subordinated debt with an original maturity of at least five years.
  
  • According to the Basel norms, if minimum Tier-1 capital falls below 6%, it allows for a write-off of these bonds.

Source: TH