What are AT-1 Bonds?

Relevancy

  • G.S. Paper 2
  • About AT-1 bonds and key points
  • Basel norms

Why in news?

  • Recently, the Reserve Bank of India (RBI) has made a proposal to write-down Additional Tier-1 (AT-1) bonds as part of the SBI-led restructuring package for Yes Bank.
  • The government and the RBI seem to have worked overtime just before the weekend to put together a bailout package for YES Bank.
  • With the SBI taking up an equity stake in the bank and a lookout on for other white knights, depositors in the troubled bank can probably look forward to an amicable resolution.
  • But one segment of investors which has been left high and dry is the holders of the bank’s AT1 bonds.

What are 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.
  • 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.

Key points about AT-1 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 optionavailable 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).
  • 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.
  • Banks issuing AT-1 bonds can skip interest payouts for a particular year or even reduce the bonds’ face value.

Basel-III Norms:

  • It is an international regulatory accord that introduced a set of reforms designed to improve the regulation, supervision and risk management within the banking sector, post 2008 financial crisis.
  • Under the Basel-III norms, banks were asked to maintain a certain minimum level of capital and not lend all the money they receive from deposits.
  • Common Equity Tier 1 capital includes equity instruments where returns are linked to the banks’ performance and therefore the performance of the share price.
  • Additional Tier-1 capital are perpetual bonds which carry a fixed coupon payable annually from past or present profits of the bank.

Risks associated with AT-1 bonds

  • The issuing bank has the discretion to skip interest payment.
  • The bank has to maintain a Common equity tier I ratio of 5%, failing which the bonds can get written down.

Who are most affected?

  • There are individuals whose money in fixed deposits was converted into the AT1 bonds with the promise of a  higher return.
  • Mainly the investors are the Institutional investors such as Mutual funds.
  • Many senior citizens also fell for the promise.

So who should invest in AT1 bonds?

  • Only affluent investors who are willing to take on higher risk of a capital loss for higher yields.