AT-1 Bonds | 14 Mar 2020

Recently, the Reserve Bank of India (RBI) has made a proposal to write-down Additional Tier-1 (AT-1) bonds as part of the SBI-led restructuring package for Yes Bank.

AT-1 bonds are a type of unsecured, perpetual bonds that banks issue to shore up their core capital base to meet the Basel-III norms.
There are two routes through which these bonds can be acquired:
- Initial private placement offers of AT-1 bonds by banks seeking to raise money.
- Secondary market buys of already-traded AT-1 bonds.
AT-1 bonds are like any other bonds issued by banks and companies, but pay a slightly higher rate of interest compared to other bonds.
These bonds are also listed and traded on the exchanges. So, if an AT-1 bondholder needs money, he can sell it in the secondary market.
Investors cannot return these bonds to the issuing bank and get the money. i.e there is no put option available to its holders.
However, the issuing banks have the option to recall AT-1 bonds issued by them (termed call options that allow banks to redeem them after 5 or 10 years).
Banks issuing AT-1 bonds can skip interest payouts for a particular year or even reduce the bonds’ face value.
AT-1 bonds are regulated by RBI. If the RBI feels that a bank needs a rescue, it can simply ask the bank to write off its outstanding AT-1 bonds without consulting its investors.

It is an international regulatory accord that introduced a set of reforms designed to improve the regulation, supervision and risk management within the banking sector, post 2008 financial crisis.
Under the Basel-III norms, banks were asked to maintain a certain minimum level of capital and not lend all the money they receive from deposits.
According to Basel-III norms banks' regulatory capital is divided into Tier 1 and Tier 2, while Tier 1 is subdivided into Common Equity Tier-1 (CET-1) and Additional Tier-1 (AT-1) capital.
Common Equity Tier 1 capital includes equity instruments where returns are linked to the banks’ performance and therefore the performance of the share price. They have no maturity.
Additional Tier-1 capital are perpetual bonds which carry a fixed coupon payable annually from past or present profits of the bank.
They have no maturity, and their dividends can be cancelled at any time.
Together, CET and AT-1 are called Common Equity. Under Basel III norms, minimum requirement for Common Equity Capital has been defined.
Tier 2 capital consists of unsecured subordinated debt with an original maturity of at least five years.
According to the Basel norms, if minimum Tier-1 capital falls below 6%, it allows for a write-off of these bonds.

RBI’s Regulations Over Banks

In a situation where a bank faces severe losses leading to erosion of regulatory capital, the RBI can decide if the bank has reached a situation wherein it is no longer viable.
The RBI can then activate a Point of Non-Viability Trigger (PONV) and assume executive powers of the bank.
By doing so, the RBI can do whatever is required to get the bank on track, including superseding the existing management, forcing the bank to raise additional capital and so on.
However, activating PONV is followed by a write down of the AT-1 bonds, as determined by the RBI through the Banking Regulation Act, 1949.