State Bank of India which is one of the largest Bank of India is planning to expand their credit giving business by raising the additional tier-1 bonds towards the end of December 2023. So that whenever there is a huge demand for credit by Asia’s No.3 economy, they will be able to cope up with that demand of the government and their countrymen and give them the loan they require. According to many sources, the State Bank of India is planning a fund Raise in the range of rupees three thousand (3000) Crore to five thousand (5000) Crore through AT-1 Bond. This transaction will take place in the next two to three weeks.
What is an AT-1 bond?
Additional Tier1 bonds are a form of “contingent convertible bonds” (i.e. hybrid instruments that are automatically transformed into equity or are written off in the event of a capital shortfall) which were created after the global financial crisis of 2007-2009 to prevent the need for government-funded bail-outs of precarious banks. These instruments are known as a hybrid of bank equity (it is the money invested by the shareholders who first instance absorbs any losses) and debt (it is the money which banks have to pay back unless they run out of equity).
How are AT-1 bonds issued?
In India, these bonds are issued by the banks in accordance with the guidelines given by the Reserve Bank of India which is one of the regulating authorities of risk-weighted assets. Capital adequacy norms are formulated under the Basel III accord of banking and finances in India. These bonds are issued by financial institutions to fulfil the capital adequacy requirements (CAR). CAR is an assessment of the bank’s capital and its 2009 after the credit crisis of 2008. These are the bonds which provide high returns but they also carry high risk.
They are ‘high-risk high reward bond’. If the banking institution fails these are the bonds which are at risk. For example, if RBI finds a bank in unstable condition, under pressure, and in the condition where that bank demands rescue. Further, the issuer can also skip the interest pay-out if it is under financial stress. In that case, the RBI can directly ask the bank to immediately withdraw their additional tier-1 bonds without seeking permission from the investors, therefore making the AT-1 bonds
Why State Bank of India is raising funds through AT-1 bonds?
State Bank of India is raising the fund through Additional tier-1(AT-1) bonds because there are many bond issuances, particularly in the infrastructure space which are happening right now, Also SBI has already raised a large amount of funds through infrastructure bonds as well as tier-2 bonds. So, now it is the time to look beyond these two and focus again on the AT-1 bonds.
What risk is associated with the AT-1 bonds?
1. Unsecured Bonds – Although these bonds give higher returns due to their perpetual nature they also carry high risk. RBI in case of instability of the bank or financial stress can directly ask the bank to withdraw their tier-1 bonds even without asking the investors and also investors might not receive the compensation.
2. Payment of Interest- These bonds carry a fixed amount of interest rate but the bank can skip or defer the interest pay-out, which affects the investor’s return.
3. Call option- the bank can recall the bonds conveniently, and the interest would stop accumulating.
The banks utilize AT-1 bonds to make their core equity base large and thus fulfil the Basel III requirements. These norms were made after the financial crisis of 2008 to regulate the banking sector. These norms mandates bank to maintain a minimum amount of funds which is specified in Basel III. These funds are designated as emergency funds which may be used in case of financial crisis. The bank’s funds are divided into tier-1 and tier-2 funds. AT-1 bonds are considered going concern capital, which means these funds will be used to meet the losses in case of instability of the bank. The Security and Exchange Board of India (SEBI) also issued certain guidelines for the mutual fund houses, which own approximately one-third of total AT-1 bonds floating in the market.
AT-1 bonds are bonds which are perpetual in nature and also provide higher returns than other traditional bonds. These bonds are used by banks to meet their capital requirements. These bonds are high-risk risk high-risk reward bonds which sometimes give a lot of profit while some of the times it may give a lot of losses. These bonds also do not have any maturity period. The investors became cautious of such bonds after the incident of Yes Bank in which investors lost a lot of money because of investing in such bonds.
Aditya Pratap is a lawyer and founder of Aditya Pratap Law Offices. He practices in the realm of real estate, corporate, and criminal law. His website is adityapratap.in and his media interviews can be accessed at http://www.youtube.com/@AdityaPratap/featured. Views expressed are personal.
This article has been assisted by Umang Pandey, a 3rd year law student pursuing B.A.LL.B. from Lloyd Law College, Greater Noida.