The Additional Tier-1 bonds or AT-1 bonds garnered a lot of attention recently. This was after the RBI decided to write-off the dues of the AT-1 bonds issued by the Yes Bank as part of the restructuring package of the bank.
Yes Bank’s AT1 bonds worth ₹8,415 crores were written down in March 2020
[You may also read: What happened to the Yes Bank?- Explained]
What are AT-1 bonds?
AT-1 bonds are perpetual bonds issued by the banks to meet their capital requirement. As per the Basel-3 norms, a bank is required to maintain a minimum of 10.5 % in tier-1 capital.
[A bank’s capital is divided into Tier 1 and Tier 2 capital. Tier 1 capital is the core capital of a bank that is permanent and reliable. It is further divided into common equity which includes equity capital and disclosed reserves and additional tier-1 capital which includes AT-1 bonds. Tier 2 capital is the supplementary capital. It includes undisclosed reserves, general provisions, bonds, provisions against Non-performing Assets, etc. Therefore, banks issue AT-1 bonds to meet their Tier 1 capital requirement. ]
[You may also read: What is meant by Basel norms in banking? What is Basel 1, 2 & 3?]
Perpetual means that there is no maturity date for the bonds. These bonds have no expiration. The issuing bank has to pay a fixed rate of interest on these bonds till eternity. But, AT-1 bonds pay a higher rate of interest as compared to other bonds issued by banks and companies. Consider this- while a high rated tier-II bond of a public sector bank may have an interest rate of 7.5% per annum, its AT1 bond can carry a rate of around 9% per annum.
But, higher returns are to compensate for higher risks.
In the case of these bonds, the issuing bank has a call option. It means that the bank has the option, but not the obligation to repay the principal after 5 or 10 years. Let’s say- there is an AT-1 bond issued by SBI with a coupon rate of 10 %. It means that the bank can choose to exercise its call option and repay the principal amount after 5 years or continue to pay 10 % interest to the bondholders forever.
The interest rates on these bonds can be paid only through annual profits, and the bank can decide to skip interest payments.
Moreover, AT-1 bonds can be written off/canceled if the bank’s capital falls below certain threshold levels. The threshold is common equity tier I ratio of 5.5%. This is what happened at Yes Bank.
These bonds are listed and can be traded on a stock exchange.
What happened with Yes Bank?
The RBI asked the Yes Bank to write-off or cancel its AT-1 bonds. These bondholders had invested around Rs.10800 crores.
This decision came as a shock to investors who had parked their money in these bonds. While most of the investors (almost 90 %) in these bonds were institutional investors like mutual funds. Some were retired individuals who had invested their life-savings in these bonds.
AT-1 bonds, as explained are risky and they had been mis-sold to retail investors as a better alternative to fixed deposits. The investors are not very well-informed about the risks and they take for granted that banks will exercise their call option always.
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