SBI may not have agreed to invest in YES Bank without AT1 write-off: RBI tells SC

Indeed, a significant factor in SBI’s decision to inject money in Yes was that these loss-absorbent bonds were to be written off before the equity infusion so that there would be no dilution of SBI’s money, the banking regulator is learnt to have said in its special leave petition before the apex court.

The condition to write-off AT1 bonds, which offer a comparatively higher return than other debt instruments, is part of the internationally accepted Basel III capital rules framed to deal with banks in dire straits. If the RBI master circular based on Basel III is questioned then no bank, according to the banking regulator, would “come forward to assist RBI in bailing out crippled banks.” It would curtail RBI’s powers and restrain it from taking decisive steps to avert a crisis like the Yes Bank one, said the central bank.

Challenging the January 2023 Bombay High Court order which had set aside the write-off of ₹8,415 crore AT1 bonds, RBI has pointed out that as on December 2022, banks had outstanding domestic AT1 bonds of ₹1,02,446 crore, of which ₹91,336 crore were issued by public sector banks. (Also, known as contingent convertibles (or Coco in banking parlance), banks issue high-return AT1 bonds to shore up capital.)

The consequences of the failure to write off AT1 bonds when chips are down, according to RBI, would mean that banks would not be able to include these bonds in the regulatory capital. This would shrink banks’ capital base, reduce their lending ability, and strain the coffers of the government which would be forced to chip in capital, feels the regulator

The Yes Bank matter, which the Supreme Court is expected to hear soon, has come up at a point when worldwide angry bondholders are opposing the decision of regulators to write-off AT1 bonds. While recently failed Swiss lender Credit Suisse took a similar step, last week regulators in Hong Kong and Singapore said that subordinated bond holders would get priority over shareholders if a bank was facing liquidation.

RBI FOCUSES ON BASEL III RULES
So, while equity holders would be hit the hardest when a bank is wound up, the question before all AT1 bondholders is: will they bear the brunt when a bank is ‘reconstituted’ or ‘reconstructed’ as a ‘going concern’ the way Yes Bank was. “Yes Bank would never have been revived unless SBI would have agreed to invest public sector money…”, says the RBI petition which mentions that the write-off was done to protect the interest of depositors and account holders. The HC order will negate the reconstruction and burden Yes with ₹8,400 crore of debt, says RBI.

According to RBI’s Basel III master circular, if a bank goes into liquidation before the AT1 instruments have been written down/ converted, these instruments will absorb losses in accordance with the order of seniority indicated in the offer document.

If a weak bank is amalgamated with a stronger bank after the AT1 bonds have been written down, the merged entity will have the right to ‘write-up’ the bonds as per its discretion. However, if a bank is reconstituted, as Yes was under section 45 of the Banking Regulation Act, such a bank will be “deemed as non-viable or approaching non-viability and both the pre-specified trigger and the trigger at the point of non-viability for conversion / write-down of AT1 instruments will be activated.”

“AT1 bond investors, some of whom had alleged mis-selling, are upset as they cannot digest the possibility where they would take the maximum hit while equity holders would be spared. Understandably they would ask: aren’t shareholders supposed to take the most risk as they stand to gain the most when times are good. This disconnect between Basel norms and standard waterfall mechanism (where bondholders are ranked above shareholders) is something that is not going down well in different markets,” said a senior banker.

Yes Bank’s ‘non-viability’, according to the petition, was triggered when RBI on March 5, 2020 announced the ‘moratorium’ on the bank subject to the central government notifying the notified scheme (which happened on March 13, 2020). The Bombay HC had set aside the decision to write off the bonds on the grounds that the RBI appointed administrator could not have taken a decision to write off (on March 14, 2020) after the scheme was notified on (March 13, 2020). But, according to RBI, the trigger for writing down AT1 bonds commenced on March 13 (upon the notification of the scheme), and accordingly the bonds were written down on March 14 prior to the injection of funds by SBI which also happened on March 14.

RBI, in its petition, has primarily based its arguments on the Basel III rules and the two bond information memorandums issued in December 2016 and October 2017.