Relaxation of Valuation of AT1 bonds

Subject: Economy

Context: SEBI has relaxed the valuation of ATI bonds after finance ministry asked for it.

Concept:

Relaxation: The deemed residual maturity of Basel III AT-1 bonds will be 10 years until March 31, 2022. It will be increased to 20 years from April 1, 2022 to September 2022, and 30 years for the subsequent six-month period. From April 2023, the residual maturity will become 100 years from the date of issuance of the bond.

About AT1 bonds:

AT-1 bonds are a type of unsecured, perpetual bonds that banks issue to shore up their core capital base to meet the Basel-III norms.
There are two routes through which these bonds can be acquired:
Initial private placement offers of AT-1 bonds by banks seeking to raise money.
Secondary market buys of already-traded AT-1 bonds.
AT-1 bonds are like any other bonds issued by banks and companies, but pay a slightly higher rate of interest compared to other bonds.
These bonds are also listed and traded on the exchanges. So, if an AT-1 bondholder needs money, he can sell it in the secondary market.
Investors cannot return these bonds to the issuing bank and get the money. i.e there is no put option available to its holders.
However, the issuing banks have the option to recall AT-1 bonds issued by them (termed call options that allow banks to redeem them after 5 or 10 years).
Banks issuing AT-1 bonds can skip interest payouts for a particular year or even reduce the bonds’ face value.
AT-1 bonds are regulated by RBI. If the RBI feels that a bank needs a rescue, it can simply ask the bank to write off its outstanding AT-1 bonds without consulting its investors.

Impact of relaxation:

There won’t be panic redemptions, but banks are unlikely to be fully happy with the partial relief.
AT1 bonds have emerged as the capital instrument of choice for state banks as they strive to shore up capital ratios. A major chunk of AT1 bonds is bought by MFs. For banks, the latest SEBI relaxation doesn’t give any major relief as they are likely to find it difficult to get investors for AT1 bonds.