The Hindu Business Line : PSBs opt for Tier II bonds to raise funds

Banks are expected to raise at least Rs 14,000-15,000 crore this year through Tier II subordinated debt. High-level banking officials said that this method of fund raising has several advantages. For instance, subordinated bond issues are available at low costs. In fact, most borrowings are being made at thin spreads over the Government securities. The latest seven-year bond issue by IDBI Bank, with early exit options at five years priced at 7.25 per cent, is at 7.35 per cent or 60 basis points over the comparable sovereign yields. Comparable five-year deposits are priced around 6.5 per cent. Term deposits appear to be cheaper.

However, subordinated bonds are exempted from reserve ratios as applicable to deposits. On deposits, bankers are expected to maintain a 25 per cent statutory liquidity ratio and 5 per cent cash reserve ratio. Both these mandated reserve ratios had returns far lower than the term deposit interest rates. These ratios, the bankers said, effectively raised the cost of term deposits.

Besides, bankers said that none of them are keen to raise their holdings of Government securities. This was because most of the banks already have Government security investments in excess of 40 per cent of their deposits. Instead, most of them prefer to reduce the holdings gradually and align them closer to the SLR of 25 per cent.

But the bankers added that most deposit accretions are short term in nature. In fact, most of the term funds coming to them are essentially demand deposits, though they are held in the form of term deposits of up to 30 days for availing of interest. This is because current accounts offer no interest earnings. Moreover, building up loan assets through short-term deposits expose banks to asset liability mismatches, which most of them prefer to avoid when interest rates are volatile. Banks preparing to fund long-term assets are using a combination of bonds and deposits to restrict mismatch risks.

The bankers added that the RBI's conversion of the investment fluctuation reserve (IFR) into Tier I capital in line with the demands made by banks allows them to increase their bond-raising abilities. Consequently, most banks have put on hold equity issue plans to shore up their Tier I capital (paid-up equity and reserves).

This is because IFR increases the capital to risk weighted assets ratio to an average of about 13.5 per cent. Ten to 11.5 per cent of this comprises Tier I capital. Under current guidelines, banks are allowed to raise Tier II capital up to 50 per cent of their Tier I capital. Consequently, additions to Tier II allow them to raise more funds by way of bonds.

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