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LVB bond shock to cost banks dear – Mint

Lakshmi Vilas Bank’s decision to write down Tier-2 bonds worth 318 crore could increase the cost of borrowing for peers, especially the weaker ones, experts said.

The troubled private bank on Thursday said it has written down all of its Basel III compliant Tier-2 bonds as advised by the Reserve Bank of India (RBI), which is arranging its merger with DBS Bank India. RBI had previously written down the entire equity capital of LVB as part of the merger.

The Tier-2 bond wipeout could be seen by investors as setting a precedent, given that these instruments can be written off just like the Additional Tier-1 bonds of Yes Bank written off earlier this year.

“Weaker banks, especially in the private sector, will find it difficult to raise Basel III Tier-2 bonds. So far, people ignored the risk of these bonds that have loss absorption clauses, but Section 45 of the Banking Regulation Act allows RBI to take appropriate action when a bank is at a point of non-viability,” said Ajay Manglunia, managing director and head at JM Financial Products.

According to Manglunia, people never understood that risk, and it is a hard lesson for investors as Tier-2 bonds are not on par with deposits. It did come as a huge surprise and shock to the people holding these papers, he said, adding lower-rated private banks will find it very hard to persuade investors to buy perpetual and Tier-2 bonds.

LVB had issued three tranches of unsecured non-convertible redeemable fully paid-up Basel III compliant Tier-2 bonds maturing between 2024 and 2025. On 9 October, Care Ratings downgraded all three tranches—of 78.1 crore, 140.1 crore and 100 crore—to B-, with a negative outlook. Care had said these bonds under Basel III have a ‘point of non-viability’ trigger, due to which investors may suffer a loss of principal.

The point of non-viability, which is determined by RBI, 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.

“Writing off LVB’s Basel III Tier-2 bonds would be seen as setting a precedent. Till now, many investors, especially non-institutional ones, would see little difference in the risk profile between deposits and Tier-2 bonds,” said Prakash Agarwal, director and head of financial institutions at India Ratings and Research.

Experts believe that the jolt from LVB’s bond write-down could lead to a more nuanced approach in approaching the risk profile of Tier-2 bonds and deposits of weak banks.

“Further, this would lead to even widening of spread of Tier-2 instruments between stronger banks and weak, mid and small private sector banks. Even smaller and weak PSU banks could see some increase in spread,” said Agarwal.

The development revived memories of Yes Bank’s resolution plan in March, when AT-1 bonds worth 8,415 crore were written off, upsetting investors. RBI governor Shaktikanta Das said in September that the primary concern of any bank should be to protect depositors’ interest. There are small depositors, middle-class depositors and retired people who depend on bank deposits, Das had said on 16 September.

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