India's new bank insolvency law to increase yields

Sun May 25, 2014 11:28pm EDT

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* Proposed rules make depositors senior to bondholders

* Analysts say subordination will affect cost of funding

* New framework may reduce yields for capital bonds

By Manju Dalal

SINGAPORE, May 23 (IFR) - India has proposed a framework for the bankruptcy of financial institutions that will align the country with international standards.

Analysts suggested, however, that the regulation will increase the cost of senior funding for Indian banks if it is implemented according to the draft submitted to the market for comments.

The proposals from a working group of the Reserve Bank of India call for depositors to have preference over senior creditors.

Analysts warned that giving depositors the upper hand over other creditors will have serious implications for bondholders, potentially leading to higher wholesale funding costs for Indian banks.

"Now that India's stand on depositor preference is very clear, we will have to review our support assumptions on debt instruments once the resolution regime comes into force," said Saswata Guha, a director at Fitch Ratings, India.

Nomura analysts expect the spreads on Indian bank senior bonds to move wider as a result of the new legislation.

"We may not see immediate widening of Indian bank's senior bonds spreads because of the Modi wave, but the impact will be gradually seen as we near the resolution implementation" said William Mak, Hong Kong-based analyst at Nomura.

Historically, no commercial bank in India has been allowed to become insolvent, though nine commercial banks were amalgamated and three went through compulsory mergers during the past decade.

The resolution regime would create a framework for an orderly wind down of an Indian financial institution.

The draft regulation also brought good news for bondholders, though.

The proposal calls for the expansion of India's existing deposit insurance agency into a Financial Resolution Authority, along the lines of the Federal Deposit Insurance Corp of the United States.

The framework under discussion will put the power to trigger writedown clauses of subordinated bonds in the hands of the new Financial Resolution Authority.

In most jurisdictions in the region, the decision to enact loss-absorption clauses on subordinated debt falls to the central bank, which can impose losses on bondholders as soon as the institution's capital falls below the minimum required.

However, the Financial Resolution Authority is expected to only get involved once the bank is already near insolvency. This means that by the time loss-absorption clauses are triggered, investors will already be potentially facing total loss on the subordinated debt anyway.

Any boost to appetite for subordinated debt will be welcome in India's local market, where banks have struggled to find investors for Basel III-compliant Additional Tier 1 and Tier 2 bonds. A tiny Rs2.8bn (US$45m) deal from Yes Bank remains India's only subordinated bond offering that qualifies as additional Tier 1 capital under the new Basel regime.

INCENTIVE FOR IMPROVEMENT

India scores poorly on the global recovery scale for bad debt with only a 30%-40% rate of recovery, partly because of weak bankruptcy laws.

Strong regulation for bank insolvency could give financial institutions greater incentive to deal with stressed assets and help address some of those failures.

India is keen to implement the resolution regime before the end of 2015, following an internationally accepted timetable. Market participants, however, warn that many hurdles remain to such a move.

"India has different regulators and legislations for different types of financial institutions like banks versus co-operative banks versus insurance companies. The resolution regime will require an altogether separate legal framework that overrides existing laws and legal resolution frameworks. This might possibly come only after a parliamentary approval," said Atul Joshi, CEO of India Ratings and Research, the local arm of Fitch.

"The resolution proposals resemble a lot [that of] advanced economies which may not be exactly suitable for peculiar Indian operational environment. Besides, the tides are contrasting too with advanced economies nationalising their banking sector and India heading for privatising," he added.

The proposed resolution regime also highlights India's relatively weak depositor protection standards. India covers less than US$2,000 in deposits, compared to insured limits of US$250,000 per person per bank in the US and S$50,000 (US$39,965) in Singapore.

The Deposit Insurance and Credit Guarantee Corporation of India held Rs377.66bn as of September 30 2013, roughly 1.7% of insured deposits. The Corporation charges an insurance premium of Rs0.10 per Rs100 deposited. This premium, as well as the amount insured, were last revised over a decade ago.

The new Financial Resolution Authority will either be created out of the Deposit Insurance and Credit Guarantee Corporation or be established as a new agency to take over its functions.

The Reserve Bank of India is seeking public comments on the proposed resolution regime before the end of May. (Reporting By Manju Dalal; Editing by Steve Garton and Christopher Langner)

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