Updated: March 13, 2021 5:00:15 pm
The decision of the Securities and Exchange Board of India (Sebi) to impose restrictions on mutual fund (MF) investments in additional Tier 1 (AT1) bonds has caused a storm in the banking and MF sectors. the The Ministry of Finance has asked the regulator to withdraw the changes as it could disrupt mutual fund investments and banks’ fundraising plans.
What are AT1 links? What is the outstanding total of these bonds?
AT1 bonuses represent additional tier 1 bonuses. These are unsecured bonds that have perpetual tenure. In other words, the bonds have no expiration date. They have a purchase option, which banks can use to buy back these bonds from investors. Banks often use these bonds to reinforce their basic or Tier 1 capital. AT1 bonds are subordinate to all other debts and are only preferred to ordinary capital. Mutual funds (MFs) are among the largest investors in perpetual debt instruments, holding more than Rs 35 billion of the additional Rs 90 billion pending Tier I bond issues.
What action has Sebi taken recently and why?
In a recent circular, the Sebi told mutual funds to value these perpetual bonds as a 100-year instrument. Essentially, this means that MFs have to assume that these bonds will be repaid in 100 years. The regulator also asked FMs to limit bond ownership to 10 percent of a scheme’s assets. According to Sebi, these instruments could be riskier than other debt instruments. The Sebi likely made this decision after the Reserve Bank of India (RBI) allowed the cancellation of Rs 8,400 crore in AT1 bonds issued by Yes Bank Ltd after it was bailed out by the State Bank of India (SBI).
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How will MF be affected?
MFs have normally treated the date of the option to purchase AT1 bonds as the expiration date. Now if these bonds are treated as 100-year bonds, the risk in these bonds increases as they become very long-term. This could also generate volatility in the prices of these bonds, since it increases the risk, increases the yields of these bonds. Bond yields and bond prices move in opposite directions and therefore a higher yield will lower the bond price, which in turn will lead to a decrease in the net asset value of the MF schemes they own. these bonuses.
Furthermore, these bonds are not liquid and it will be difficult for MFs to sell them to cope with the pressure of rescue. “Potential repayments from this new rule would lead mutual fund houses to panic bonds in the secondary market, leading to higher yields,” said Uttara Kolhatkar, partner at J Sagar Associates.
What is the impact on banks?
AT1 bonds have become the capital instrument of choice for state banks in their effort to shore up capital ratios. If there are restrictions on mutual fund investments in such bonds, banks will find it difficult to raise capital at a time when they need funds from soaring bad assets. Mutual funds buy a large portion of AT1 bonds. State banks have cumulatively raised around $ 2.3 billion in AT1 instruments in 2020-2021, amidst a virtual absence of such issuance by private banks (barring one instance) as a consequence of AT1’s write-off of Yes Bank in March 2020. AT1 instruments are still accounted for for a relatively small proportion of the capital structure (averaging around one percent of risk-weighted assets), but are increasingly finding favor with state banks, apparently as an alternative to stocks, Fitch Ratings said.
Why did the Finance Ministry ask Sebi to review the decision?
The Ministry of Finance has sought the withdrawal of the valuation rules for AT1 bonds prescribed by the Sebi for mutual fund houses, as it could lead to mutual funds losing and exiting these bonds, which would affect the plans. of capital raising of the banks of the PSU. The government does not want an interruption in the banks’ fundraising exercise at a time when two PSU banks are in the privatization bloc. Banks have yet to receive the proposed capital injection in fiscal year 21, although they will need more capital to meet asset quality challenges for the foreseeable future. Fitch’s own estimate pegs the sector’s capital requirement between $ 15 billion and $ 58 billion under various stress scenarios for the next two years, of which state banks account for the largest share.
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