Teathe saga of Additional Tier-1 (AT1) Bonds continues. It started with the sale of these bonds by Yes Bank in the form of high-interest-bearing fixed deposits to retail investors, followed by a series of events in early 2020 – bank in trouble due to bad loans, RBI-appointed administrator wrote them off, the bondholders filed a court case, the Bombay High Court set aside the write-off decision, and the matter is now likely to go to the Supreme Court.
This series of events highlights the various ways in which financial regulation has been flouted in India.
yes bank saga
In 2016 and 2017, Yes Bank issued AT1 bonds to increase its capital base. The bonds offer a higher yield than other comparable bonds.
Hunt? In the event of a crisis, they can be converted into equity, or written off. That is, if you bought these bonds, you would get a higher interest rate (compared to a fixed deposit), but if the bank got into trouble, there was a chance that you would not be paid the interest, or your bond would be converted into equity. Will happen
As of March 2020 it was public knowledge That Yes Bank was in financial distress due to some of its loans becoming non-performing assets (NPAs). RBI Appointed An administrator supersedes the board to deal with the solvency of the bank.
The administrator made a plan for its revival – State Bank of India along with some other financial institutions would buy equity, while AT1 bondholders would get nothing.
Read also: The growth of India’s NBFCs means more compliance, regulations. go digital to keep track
misselling of bonds
The first problem is the marketing pitch for the bond. It has been alleged that Yes Bank employees overemphasized the returns and underestimated the risks of investing in these bonds.
Mis-selling by bank employees is nothing new. they have been Familiar To recommend the product with the highest fee paid, and rarely disclose costs and lock-in. Consumer protection regulation by the Reserve Bank of India is yet to elicit a widespread response to such practices.
In the case of Yes Bank, SEBI (Securities and Exchange Board of India) imposed a a punishment on Rana Kapoor, the managing director of the bank, for mis-selling. it further forbidden Retail investors should avoid investing in these bonds.
In typical Indian style, we have not addressed the systemic problem behind the mis-selling, but have completely banned retail investors from investing. It assumes that retail investors are mute, and cannot make a risk-reward tradeoff once relevant disclosures have been made. The decision means that banks are deprived of a source of funds and retail investors are deprived of a source of high interest yielding instruments. Little has changed in the way frontline workers are distributed.
Read also: Think Twice Before Tax Fraud, Authorities Are With You With AI
Yes Bank Resolution
The second problem with regulation is the delay and unpredictability of how the regulator deals with failed banks. In case of Yes Bank underreporting The number of bad loans peaked at the beginning of FY16.
As of 2019, credit rating agencies had downgrade bank, and its market value was worn out, StoppageHowever, it was kept on 5 March 2020 only. Important time lost.
as discussed somewhereThere is an inherent conflict of interest in the role of RBI as a regulator of banks and as a resolution authority. There has been no consistency in the way bank failures have been resolved in the past. sometimes they were sold into private equity funds, sometimes merged with other public sector banks, and sometimes devalued bonds.
This reflects the absence of a framework for resolution of financial firms, lack of regulatory clarity. government’s withdrawal The proposal of the Financial Resolution and Deposit Insurance (FRDI) Bill in 2018 is yet another example of missed opportunities to reform India’s financial sector.
debt write off
The third and perhaps the biggest problem is the write-off of debt in exchange for equity.
Basel III Norms Guidance from banking regulators suggests that AT1-type bonds be junior to all other debt, but senior to a bank’s common equity capital. It’s a recap of how finance works.
Equity holders get upside benefits if the firm does well but stand to lose their capital if it fails. Debt holders do not get upside, but get paid before equity in the event of bankruptcy. This logic backfired in the Yes Bank case.
Technically, RBI may be able to refer to master circular To justify the decision of the administrator. But the big question is whether there was any merit in challenging a provision that goes against the logic of how debt and equity work.
The administrator’s ability to write off debt before equity essentially meant that most institutional investors would be reluctant to invest in these bonds, drying up another important source of capital for banks because the fundamentals of finance defy,
The matter is now in the Supreme Court. Despite the apex court’s decision, fundamental questions around the design of financial regulation are still unresolved. We need to relook at our framework on consumer protection, resolution of financial firms and rights of creditors.
Renuka Sane is Director of Research at TrustBridge, which works on improving the rule of law for better economic outcomes for India. Thoughts are personal.
(Editing by Therese Sudip)