Bank are projected to face challenges in incremental debt issuance

Lenders are projected to face challenges in their incremental bond issuances, following the Sebi (Securities and Exchange Board of India’s) revised norms on investment by mutual funds in Basel III debt instruments issued by banks, says a report.

In the last week’s revised norms, the capital market regulator said mutual funds across all the schemes wouldn’t own quite 10 percent of the Basel III instruments issued by any bank.

The norms also mention that no quite 10 percent of Net Asset Value (NAV) of the debt component of the scheme shall be issued in Basel III instruments and no quite 5 percent of the NAV of the debt component of the scheme shall be issued in Basel III instruments of one issuer.

In addition, the valuation of perpetual debt instruments (PDIs) henceforth shall be supported a maturity of 100 years from the date of issuance rather than the current practice of valuing them on time left for subsequent call-option date.

Icra Ratings Group Head (Financial Sector Ratings) Karthik Srinivasan said the proposals to limit the composition of the Basel III bonds in overall asset under management (AUMs) could affect incremental investment appetite of AMCs which are closer to 10 percent of NAV threshold limit for investments in these bonds.

“As mutual funds are large investors in additional tier I (AT-I) and tier-II bonds issued by banks, it could possibly make it challenging for the banks to boost their desired quantum of debt capital,” Srinivasan said within the report.

As per the rating agency, mutual funds hold 30 percent of the outstanding tier I bonds and 14 percent of the outstanding tier-II bonds as of February 2021.

Moreover, the holding of Basel III AT-I and tier-II instruments is estimated at 8 percent of AUMs of the schemes holding these instruments, thereby limiting headroom for incremental investments, it said.

The agency, in its outlook for the banking sector for FY2022, had estimated the tier I capital requirements for public sector banks (PSBs) at Rs 43,000 crore, of which Rs 23,000 crore is on account of call-options falling due on AT-I bonds of PSBs, while the balance is estimated because of the equity.

In the Union allow FY2022, the govt has already announced an allocation of Rs 20,000 crore as equity capital for the recapitalization of PSBs.

“If the market of the AT-I bonds remains dislocated for an extended period for aforementioned reasons and therefore the PSBs aren’t ready to replace the prevailing AT-Is with fresh issuance, this is able to mean that the PSBs could stare at a capital shortfall supported the budgeted capital,” it said.

While there might be challenges in replacing the capital due to this development, the agency continues to think about the requisite capital support from the govt for PSBs to enable these banks to satisfy the regulatory capital ratios.

“Hence, the event is probably going to be credit neutral for public banks,” it said.

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