* 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
The proposals from a working group of the Reserve Bank of
India call for depositors to have preference over senior
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
"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
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,
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
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
"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
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