MUMBAI: The new guidelines issued by the Reserve Bank relaxing additional tier 1 (AT1) bonds issued under Basel III will bolster ability of banks, especially the weak public sector ones, whose funds will double to Rs 2.34 trillion, thus helping avoid bond defaults, say analysts.
"For the weaker public sector banks the risk of their not being able to service the coupon on AT1 bonds has significantly abated with this measure. This will ensure that state-run banks will have as much as Rs 2.34 trillion at their disposal now as against Rs 1.24 trillion earlier," domestic rating agency Crisil said in note.
Global rating agency Fitch welcomed the move, saying this will also help them raise domestic capital but does not fully eliminate the default chances for the weakest banks.
"The RBI decision avoids potential damage to sentiment in domestic AT1 market, which will have made it even harder for banks to raise the large amount of new capital that they require over the next two years," Saswata Guha, a director at Fitch said in a weekend note.
He said banks' statutory reserves is 25 per cent of their profits now.
On February 2, RBI amended the regulations governing AT-1 bonds under the Basel-III framework, wherein it allowed lenders to pay coupons from profits and reserves.
"Coupons must be paid out of 'distributable items'. In this context, coupon may be paid out of current year profits," it said in a notification, amending Para 1.8(e) of Annex 4 of the July 1, 2015 Master Circular on Basel-III. The amendments are applicable with immediate effect.
Guha further said by allowing banks to also make AT1 payments from statutory reserves, into which banks place 25 per cent of their profits, RBI has reduced a potential trigger for skipped payments.
The practice of dipping into statutory reserves for distributions is unusual but not full unheard of as Italy and Portugal allow this for some payments," Guha said, adding this underlines pressures that have built in the banking sector.
Earlier, banks could serve AT1 coupons only from either their profits or from revenue reserves only.
The new RBI move comes amidst a massive rise in bad loans, which touched over 15.8 per cent of the total system as of September 2016 and the government's inability to infuse more capital into them. The Budget 2018 has allocated a paltry Rs 10,000 crore capital infusion against an actual demand that is multiple times.
By March 2019, the banks over Rs 2.5 trillion in fresh capital to meet the stringent Basel III capital norms.
Last October Crisil had warned that some state-run banks would be facing problems in serving their AT1 bonds, and had warned that a sharp decline in profitability and mounting losses can wipe out their revenue reserves and hamper their near-term ability to service AT1 bonds.
"The new guidelines mean the near-term challenge of servicing coupon for these PSBs, has been resolved," Krishnan Sitaraman, senior director, Crisil said, adding, "we estimate the reserves available with state-run banks to service AT1 bond coupons, under revised guidelines, is nearly double at Rs 2.34 trillion from Rs 1.24 trillion earlier."
To date, public sector banks have issued around Rs 39,000 crore of AT1 bonds of which Rs 21,500 crore were issued this fiscal year itself.
As per Guha of Fitch, the move highlights the impact of persistent losses and weak internal capital generation by banks, which has left some lenders lacking distributable reserves and at risk of skipping default.
"Banks will require around USD 90 billion in new total capital by fiscal 2019 to meet Basel III standards, with around 30 per cent of this needing to be met through AT1 bonds. Skipped coupon payments would have made issuance even harder, even for the healthier banks. In that respect, the RBI decision is an exercise in damage control," Guha said.
Fitch also said while the move is good for AT1 investors, it should be seen as negative for senior creditors who should be protected by AT1 investors taking losses.
"The decision also weakens market discipline that AT1 bonds should help create--the risk of missing payments should be an incentive for banks to recapitalise by raising equity. For state banks, allowing coupon payments from statutory reserves helps push out the need for government to inject more capital. The move, however, does not remove the risk of default," Guha concluded.
Last Friday, the RBI, under the revised guidelines, has broadened the scope of available statutory reserves through which banks can service coupons on AT1 bonds.
According to Crisil assessment, the reserves available for AT1 coupon servicing, under the new norms, include the reserves representing appropriation of net profits--which include statutory reserves, capital reserves on sale of investments, other capital reserves--special reserves and revenue and other reserves, adjusted for accumulated losses and deferred revenue expenditure.
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