AT-1 bonds & Yes Bank Crisis

What are AT-1 bonds & Yes Bank Crisis

BASEL-III

It introduced a set of reforms designed to improve the regulation, supervision & risk management within the banking sector

Under the Basel III norms, Banks were asked to maintain certain minimum level of capital

Under the Based III framework, banks' regulatory capital is divided into Tier 1 and Tier 2 capital.

Tier 1 capital is subdivided into Common Equity (CET) and Additional Capital (AT1).

Common Equity Tier 1 Capital

It includes equity instruments where returns are linked to the Bank's performance and therefore the performance of the share price.

Additional Tier-1 bonds

They are a type of unsecured, perpetual bonds that banks issue to shore up their core capital base to meet the Basel-III norms.

Key features:

1. These have higher interest rates
2. These bonds have no maturity date.
3. The issuing bank has the option to call back the bonds or repay the principal after a specified period of time.
4. The attraction for investors is higher yield than secured bonds issued by the same entity.
5. They are listed & traded on stock exchanges.

However, it has a two-fold risk:

1. First, the issuing bank has the discretion to skip coupon payment.
2. Second, the bank has to maintain a common equity tier I ratio of 5.5%, failing which the bonds can get written down. In some cases there could be a clause to convert into equity as well.

Given these characteristics, AT1 bonds are also referred to as quasi-equity.

How RBI can take over the regulation of any bank?

There is an additional trigger in Indian regulations, called the ‘Point of Non-Viability Trigger' (PONV).

• In a situation where a bank faces severe losses leading to erosion of regulatory capital, the RBI can decide if the bank has reached a situation wherein it is no longer viable.
• The RBI can then activate a PONV trigger and assume executive powers.
• By doing so, the RBI can do whatever is required to get the bank on track, including superseding the existing management, forcing the bank to raise additional capital and so on.
• However, activating PONV is followed by a write down of the AT1 bonds, as determined by the RBI.

Who are most affected?

• Mainly the investors that are the institutional investors such as Mutual funds.
• But there are also individuals whose money in fixed deposits was converted into AT-1 bonds with the promise of higher return.

So only affluent investors who are willing to take on higher risk of a capital loss for higher yield should invest in AT-1 bonds.