Yes Bank’s court ruling undermines the concept of AT-1 bonds that reduce losses

In the wake of the global financial crisis of 2007–09, the Bank for International Settlements and its Basel Committee on Banking Supervision recommended tighter capital requirements and regular stress testing for banks. AT-1 bonds are flown by the committee’s so-called Basel III norms. AT-1 bonds are perpetual bonds issued by banks to absorb losses as a capital buffer and sit alongside common equity in Tier 1 of the bank’s capital structure. They are issued with the clear understanding that they can be written off if the bank runs into trouble, but it remains a going concern and tends to coupon more than the market to reflect this element of risk. Is.

Systemically important banks – very large banks whose collapse would affect not only their depositors, bondholders and investors but the financial system itself – need to build higher loss-absorbing capital buffers in addition to AT-1.

In 2020, India’s banking regulator, the Reserve Bank of India, put Yes Bank under moratorium, removed its existing management and placed it under an administrator. The administrator decided to write off the AT1 bonds. The bondholders were naturally incensed and challenged the decision. There was no merit in their protest: after all, they knew the inherent, risky nature of AT-1 bonds and were willing to accept that risk in exchange for the better returns on offer. He challenged the write-off in the High Court.

A division bench of the High Court upheld his challenge not on merits, but on procedural grounds. The administrator informed the stock exchange about the decision to write off the AT-1 bonds a day after a new plan of reconstruction of the bank, complete with new management, was notified. The High Court ruled that the Administrator lost the power to write off AT1 bonds after the Plan of Reconstruction was notified, and thus did not have the authority to write off AT-1 bonds.

But two questions arise. Relates to the validity of a court’s procedural reasoning. Has the administrator lost his authority upon notification of the new management? Who was in charge between the notification of the new management and its taking over? Should the bank have been placed under a managerial vacuum, or was the administrator in charge until new management took over? Is the decision to write off AT1 bonds applicable only on the notification of the stock exchanges?

The bigger question pertains to the regulatory regime for the financial sector. If the banking regulator followed regulatory process when the Basel Committee on Banking Supervision established the Basel III norms in an attempt to prevent a mismanaged bank from failing and infecting other transaction partners with its disease, would the court should stop the process? An additional wrinkle is that while the draft reconstruction plan included a measure to write off the AT1 bonds, the final reconstruction plan did not include this following a demand raised by AT1 bondholders that the bonds be converted to equity instead of being written off.

The RBI and its administrators do not come out smelling of roses from such alleged lapses and lapses. But this does not undermine the purpose of AT-1 bonds and the validity of writing off these bonds to absorb losses due to bank insolvency. It is to be expected that this matter will be clarified when the High Court judgment is appealed against in the Supreme Court.

The whole point of Kafka’s black allegory is to bring out the alienating, disruptive effect of rules administered without any concern for the purpose of having the rules in place in the first place. Emerging India cannot afford a precedent that dilutes the concept of loss-absorbing AT-1 bonds.