RBI amendments encourage Basel III-compliant bonds

Author: Ashley Lee | Published: 5 Sep 2014
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The Reserve Bank of India (RBI)’s amendments to its Basel III guidelines buck global trends on write-downs and on retail investors participating in the regulatory capital market.

The amendments, notified on September 1, included several surprising elements. They reintroduce temporary write-downs to the market – after a previous notification said that they would no longer be permitted – and now permit retail investors to buy Basel III-compliant bonds.

The guidelines were reviewed with the aim of facilitating the raising of non-regulatory capital instruments by banks under Basel III framework, said RBI chief general manager-in-charge Sudarshan Sen in a letter accompanying the guidelines. They are also intended to incentivise investors and to increase the investor base.

KEY TAKEAWAYS

  • RBI’s amendments to its Basel III regulations have reintroduced temporary write-downs;
  • Retail investors will also be permitted to invest in both AT1 and T2 bonds;
  • It’s hoped that the amendments will prompt Indian banks to issue bonds to meet regulatory capital requirements


Retail investors

According to the new guidelines banks may now issue Additional Tier 1 (AT1) and Tier 2 (T2) products to retail investors.

RBI’s decision to allow retail investors to invest in Basel III-compliant bonds diverges from that of other regulators; recently the UK’s Financial Conduct Authority announced that contingent convertible (CoCo) bonds could not be sold to retail investors.

While there have been no true CoCos in the Asia ex-Australia market, regulators across the region have expressed concerns that retail investors may not understand the risk of the point of non-viability (PONV), and the meaning of full or partial write-downs.

The practice is also banned in the Philippines where retail investors in the Philippines are not permitted to invest in Basel III bonds. Thai retail investors were also restricted from investing in Basel III bonds, but that’s changed following the change in government.

Sources in India questioned whether this was actually a good development for the market. While RBI may be taking a view towards developing the debt markets, Indian retail investors have little experience in bond investments outside tax-free bonds.

In its notification RBI seemed to take that into account. The loss absorbency features of the instrument should be clearly explained and the investor’s sign-off for having understood those features other terms and conditions should also be obtained, it said.

Temporary write-downs

The RBI has also reversed its previous stance on temporary write-downs. They were originally included in India’s Basel III regulations; the country was the only one in Asia to permit a temporary write-down, but no specific regulations were released about how they would actually work.

RBI then removed them as an option in April.

They have now been reintroduced in the regulations, which means that they are now a possible feature in Indian bank capital. It’s unclear whether their return will spark new deals.

But they’re unlikely to affect ratings. Saswata Guha, director at Fitch India, insisted that they’ve always been very clear as far as AT1s are concerned. They will mark AT1 bonds down from their standalone ratings by at least five notches, which includes loss severity and non-performance risks.

"I don’t believe that the provision of temporary write-downs would necessarily lead to a change in Fitch’s criteria," he said.

That might change slightly for T2s. "On T2s, we have a slightly more discretionary approach for very large systemically important banks (SIBs) wherein we may factor in support for the Tier 2 bonds," he said.

But that’s something that will be considered for very few banks, in which case the Tier 2 bond rating will be notched off the default rating – not the standalone rating.

What’s next

Earlier this year the RBI delayed its timeline for Basel III, delaying its full implementation from March 31 2018 to March 31 2019.

It also decreased its pre-specified trigger for the point of non-viability: all AT1s sold before March 31 2019 will have a common equity tier 1 (CET1) ratio requirement of 5.5% of risk-weighted assets until that date, after which the trigger will be revised up to the original 6.125%. All other AT1 bonds issued after that date will also have a trigger of 6.125%.

But those changes didn’t spark AT1s in India. So far two banks have sold AT1 bonds: Yes Bank and Bank of India.

It’s hoped that these new regulations will incentivise banks to turn to the debt markets. "The key question now is, by virtue of these amendments whether you’ll see activity in the Indian markets," said Guha. "Our sense is that we will."

See also

Troubled bank to clarify India’s Basel III commitment

Asia bank capital series: Indian Basel III implementation explained

Asia’s Basel III Tier 2 bond evolution continues