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Risk premiums for Basel-III complaint Tier-2 Bonds could go up for weaker private banks following the Reserve Bank of India’s (RBI) advice to Lakshmi Vilas Bank (LVB) to write down these bonds aggregating ₹318.2 crore before its amalgamation with DBS India Ltd (DBIL) comes into effect.
The amalgamation comes into force on the appointed date – November 27. All branches of the troubled LVB will function as branches of DBIL, which is awholly-owned subsidiary of DBS Bank, Singapore, with effect from Friday.
Anil Gupta Sector Head – Financial Sector Ratings, ICRA, said the RBI has set a precedence with the proposed write down as it is the first time that a Tier II bond is being written off.
He opined that investors should factor in the risk in Basel III instruments, as these instruments can be completely written down in case a bank gets into trouble.
‘Lakshmi Vilas Bank has enough liquidity to pay depositors’
Gupta expects the risk premiums for such instruments to increase for weaker private banks in the backdrop of the merger of LVB with DBIL.
Banks’ Base1 III compliant Tier II Bonds are in the nature of unsecured, non-convertible, taxable, subordinated, redeemable, and fully paid-up debentures.
According to ICRA, the Basel III – Tier II bonds are expected to absorb losses once the point of non-viability (PONV) trigger is invoked.
Loss of principal
CARE Ratings said Tier II Bonds under Basel III are characterised by a ‘Point of Non-Viability’ (PONV) trigger due to which the investor may suffer a loss of principal.
The agency observed that PONV will be determined by the RBI and is a point at which the bank may no longer remain a going concern on its own unless appropriate measures are taken to revive its operations and, thus, enable it to continue as a going concern.
In addition, the difficulties faced by a bank should be such that these are likely to result in financial losses, and raising the Common Equity Tier I capital of the bank should be considered as the most appropriate way to prevent the bank from turning non-viable, CARE Ratings said.
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