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* Capital plunge may trigger bail-in of subordinated
* Move would test assumptions of state support for Indian
* Problems over application of Basel rules to state-owned
By Manju Dalal
SINGAPORE, Feb 14 (IFR) - A worsening capital crisis at one
of India's smaller state-owned lenders is setting the scene for
Asia's first test of regulators' attitudes towards subordinated
Kolkata-based United Bank of India last year became the
first Indian bank to issue loss-absorbing securities, often
dubbed "bail-in bonds", to supplement its regulatory capital
under the Basel III regime.
Mounting credit losses have left UBI's capital ratios
dangerously low, and Fitch Ratings warned this week that UBI's
common equity tier 1 and Additional Tier 1 ratios may fall below
5% for the full financial year ending in March.
Analysts are expecting the government to bail out the bank,
but the treatment of UBI's subordinated creditors will offer the
first hint at how regulators in one of Asia's biggest emerging
markets plan to interpret Basel III rules.
The Reserve Bank of India, like many other Asian regulators,
has not clearly defined the point at which it will force sub
debt holders to take losses, as required under the terms of
Basel III, but it has the power to do so on the Tier 2 bonds UBI
issued last year.
Declaring the bank to be no longer viable would trigger
Asia's first bail-in of subordinated bank debt.
Such a move would offer an indication of the RBI's attitude
towards the Basel III regime, hinting at India's commitment to
enforcing the new global standards. In India's largely
state-owned financial sector, however, it poses a dilemma.
No state-owned Indian bank has ever been allowed to fail,
giving rise to a belief that state ownership implies a moral
obligation on the government to support public sector banks.
That suggests the fall-out from triggering the
loss-absorption clause on UBI's bonds would lead to a swathe of
downgrades in the country and to higher funding costs for
India's already capital-strained banks.
Adding to the complication, UBI's loss-absorbing sub debt is
held by state-owned Life Insurance Corp of India, the sole
investor in UBI's Rs5bn (US$80m) placement of Tier 2 bonds last
"The RBI is truly in a dilemma. If the central bank does not
bail out UBI, people will be screaming blue murder and if it
does, this decision will encourage investors to buy riskier
paper (of state-owned banks)," said a Mumbai-based DCM banker.
On February 7, UBI reported a net loss of Rs16.8bn for the
nine months ending December, down from a Rs3.6bn profit in the
same period the previous year. UBI's gross non-performing assets
ratio increased to 10.8% in December, up sharply from 5.6% in
June last year.
The losses have brought UBI's current total capital ratio to
9.01%, within a whisker of the minimum 9% requirement.
Worse, its Tier 1 ratio has dropped to 5.6%, below the RBI's
minimum common equity tier 1 requirement of 6.5% and below the
6.125% level that would trigger loss-absorption clauses on
Additional Tier 1 instruments under the new regulatory framework
As a result of its losses, UBI will be barred from paying a
coupon on the Rs5bn of Basel III-compliant Tier 2 bonds it sold
to LIC, and may be forced to write down those instruments in
full if the RBI declares the bank to be no longer viable.
Market participants seem divided on what route the RBI
"The RBI has an opportunity to set a precedent in the light
of Basel III. Options are limited as one can either choose to
bail-out hybrid debt investors or allow loss-absorbing
instruments to take losses first which is also consistent with
the Basel III approach," said Saswata Guha, an analyst at Fitch
"In fact, whichever step the central bank takes in the light
of Basel norms, it will give clarity to investors at a time when
Indian banks are planning US dollar Basel III-compliant
offerings," Guha said.
Others, however, caution that triggering the loss-absorption
clause would send shockwaves through the Indian financial system
as investors are forced to reassess their expectations of state
Forcing subordinated creditors to take losses would call
into question the approach of rating agencies such as Crisil,
which have assigned high ratings to loss-absorbing bonds in
India on the premise that the RBI will not allow a state-owned
bank to fail.
In its June 13, 2013 release assigning UBI's Rs5bn new-style
Tier 2 bonds an AA+ rating, Crisil said: "A robust regulatory
and supervisory framework and systemic importance of the banking
sector is expected to ensure adequate and timely intervention by
RBI to avoid a situation wherein a bank becomes non-viable."
Icra and Crisil each cut their ratings of UBI's sub debt
this week, but kept them at investment-grade ratings.
Ultimately, though, RBI may find a solution that does not
trigger a write-down. UBI has already received Rs7bn from the
government in the current financial year, without any talk of
non-viability, while in October, the Indian Government announced
a capital infusion of Rs140bn in 20 state-run banks by the end
India's banking secretary Rajiv Takru said on Wednesday that
the government may consider injecting additional capital into
UBI. Analysts said the bank will require at least Rs5bn in the
current quarter to stay afloat.
According to the RBI, Indian banks will need to raise Rs5trn
by March 2018 to become fully compliant with Basel III
requirements. Of this, nearly Rs1.75trn will come through equity
capital and the remainder in the form of Additional Tier 1 and
Tier 2 securities.
(Reporting By Manju Dalal; editing by Christopher Langner and