Lakshmi Vilas Bank’s decision to amortize the value of Tier-2 bonds ₹Rs 318 crore could increase the cost of borrowing for peers, especially the weaker ones, experts said.
The troubled private bank said on Thursday that it has written off all of its Basel III-compliant Tier-2 bonds as advised by the Reserve Bank of India (RBI), which is organizing its merger with DBS Bank India. RBI had previously listed all of LVB’s share capital as part of the merger.
Investors may consider the elimination of Tier 2 bonds to set a precedent, as these instruments can be canceled just like Yes Bank’s additional Tier 1 bonds canceled earlier this year.
“Weaker banks, especially in the private sector, will find it difficult to obtain Basel III Tier 2 bonds. Until now, people ignored the risk of these bonds that have loss-absorbing clauses, but Section 45 of the Banking Regulation Act allows RBI to take appropriate action when a bank is at a point of non-viability, “he said Ajay Manglunia, Managing Director and Head of JM Financial Products.
According to Manglunia, people never understood that risk and it is a difficult lesson for investors, as Tier-2 bonds are not on par with deposits. It was a big surprise and shock to the people holding these papers, he said, adding that lower-rated private banks will find it very difficult to persuade investors to buy perpetual and Tier 2 bonds.
LVB had issued three tranches of unsecured, non-convertible, redeemable, fully disbursed Tier-2 bonds that are in compliance with Basel III with maturity between 2024 and 2025. On October 9, Care Ratings downgraded the three tranches from ₹78.1 crore, ₹140.1 crore and ₹100 crore – to B-, with a negative outlook. Care had said that these Basel III bonds have a “point of non-viability” trigger, due to which investors may suffer a capital loss.
The point of non-viability, which is determined by the RBI, is a point at which the bank can no longer remain a going concern on its own unless appropriate steps are taken to reactivate its operations.
“The cancellation of LVB’s Basel III Tier 2 bonds would be seen as a precedent. Until now, many investors, especially non-institutional ones, would see little difference in the risk profile between deposits and Tier-2 bonds, “said Prakash Agarwal, director and head of financial institutions at India Ratings and Research.
Experts believe that the lurch from LVB’s bond depreciation could lead to a more nuanced approach in addressing the risk profile of Tier 2 bonds and weak bank deposits.
“Furthermore, this would lead to a widening even of the spread of Tier 2 instruments between stronger banks and weak, medium and small private sector banks. Even the smallest and weakest PSU banks could see some increase in spread, “Agarwal said.
The development revived memories of Yes Bank’s resolution plan in March, when AT-1 bonds were worth ₹Rs 8,415 million were written off, upsetting investors. RBI Governor Shaktikanta Das said in September that the main concern of any bank should be to protect the interests of depositors. There are small depositors, middle class depositors and retirees who depend on bank deposits, Das had said on September 16.
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