A bond between viability and debt characteristics
The government on March 13 notified the Yes Bank Limited Reconstruction Scheme, 2020, prepared by the Reserve Bank of India (RBI).
Together with implementation of the scheme, Yes Bank has indicated that it will be writing down permanently and in full certain instruments qualifying as Additional Tier 1 (AT1) capital issued by it under the Basel III framework. However, common equity remains on the bank’s books without any write-down.
While the decision is in line with the regulatory framework governing Basel III AT1 bonds, it seems contrary to conventional wisdom that bonds are generally senior to common equity. This has caused quite a stir in the credit market, with questions raised on the inherent risks in these instruments.
Before we come to all that, let us take a look at the quantum of Basel III AT1 instruments outstanding and their key features. As on December 31, 2019, around Rs 90,000 crore of such bonds were outstanding, of which close to 60% belonged to public sector banks and the rest to their private peers (details in annexure 1).
These bonds are hybrids with features of both equity and debt (see box, Salient features of Basel III AT1 instruments).
For weak banks, or those less viable ones such as Yes Bank, these instruments start behaving more like equity and less like debt. Hence, according to CRISIL’s rating criteria, the notch-down for weak banks from the issuer rating could be substantial at three notches or more.