* Bank uses loophole to sell capital bonds to non-bank
* Yes Bank buys sub-debt from investor in return
* Bankers fear Reserve Bank of India could stop future deals
By Manju Dalal
SINGAPORE, Jan 10 (IFR) - Private-sector lender Yes Bank has
found a creative, albeit controversial, solution to India's
struggle to attract investors to subordinated bank capital
On December 31, the issuer privately placed India's first
Basel III-compliant Tier 1 bond with a single investor,
Indiabulls Financial Services,one of the country's biggest
non-bank lenders. Indiabulls bought the Rs2.8bn (US$45m)
non-call 10 perpetual bonds at a yield of 10.5%.
While it was far from the first private placement in India's
struggling bank capital market, sources said the deal came
alongside a parallel placement in which Yes Bank agreed to buy a
similar amount of Indiabulls' subordinated debt.
Such a quid-pro-quo arrangement between two banks would come
with no capital benefit, since Indian regulations require
lenders to count any sub bonds they buy from other banks against
their own capital - a rule designed to ensure risks are spread
beyond the banking sector.
However, that rule does not apply to sub debt from
non-banking financial companies, meaning Yes Bank and Indiabulls
are each in line for a capital boost.
Market participants were quick to criticise the scheme.
"Yes Bank's deal is a cosy arrangement. As a pricing benchmark
it is not sending the right signal to the market," said a DCM
banker away from the deal.
Others saw it as a challenge to the Reserve Bank of India.
"Yes Bank's deal is ground-breaking, but, I feel they have gone
a bit far by challenging the authority of the central bank,"
said a Mumbai-based banker.
Both parties have not breached any regulations and Basel
rules do not prohibit cross-holdings of sub bonds. However, such
a deal also leaves the risk embedded in India's financial
system, rather than reducing the chances of a bank failure
becoming a systemic crisis.
The controversial deal, though, was born of necessity. Local
investors have been shying away from buying new-style capital
bonds because of the loss-absorption features, while Indian
banks are under pressure to lift capital ratios.
"There will be a good supply of additional Tier 1 from
Indian lenders. Hence, it is quite crucial to have a good base
of institutional investors, who can buy such bonds. In this
context, Yes Bank's deal looks like a good start," said Karthik
Srinivasan, an analyst with Icra.
NO LOCAL BID
Under Basel III rules, all sub debt that counts toward a
bank's capital must absorb losses, either through conversion to
equity or a write-down at the point a bank becomes non-viable.
In addition to the loss-absorption features, T1 bonds face
two major obstacles with local investors. First, many debt
investors are restricted from investing in debt instruments with
equity-like features due to the higher risks involved. Second,
as ratings on T1 bonds are typically at least three to four
notches below a lender's senior unsecured rating, these
instruments automatically fall below the rating thresholds for
Local rating agency Icra assigned an A to Yes Bank's Rs3bn
Basel III-compliant bond programme. The rating is three notches
lower than the bank's Basel II-compliant Lower Tier 2 bonds.
Most Indian investors are restricted to buying bonds rated at
least Double A.
For these reasons, the Rs107.5bn of Tier 2 bonds issued so
far under the Basel III rules in India have struggled to attract
wider investor participation. Most of the bonds issued so far in
the country have been bought a single investor, the Life
Insurance Corporation of India.
Only recently, another big investor, the Employees'
Provident Fund Organisation, has started buying Tier 2 bonds,
including the recent Rs20bn Tier 2 deal from State Bank of
India, the country's largest lender. The bank placed the 10-year
bonds at 9.69%. However, the public pension fund and other key
investors, such as insurance companies and provident funds,
cannot buy Tier 1 instruments.
At the same time, though, some have been celebrating the
deal as a solution for a shortfall in potential investors for
sub debt at a time when Indian banks are in dire need of
According to the RBI, banks will need to issue Rs5trn of
additional capital over the next four years ending March 2018.
Common equity is expected to make up about Rs1.75trn of this new
capital with debt accounting for the remaining Rs3.25trn. That
includes about Rs1.9trn of Tier 1 and Rs1.35trn of Tier 2 bonds.
The RBI has also been raising capital adequacy requirements
for non-bank lenders in recent years.
Yes Bank and Indiabulls did not respond to requests for
(Reporting By Manju Dalal; Editing by Christopher Langner and