LVB’s decision to write off bonds may impact banks

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Troubled Lakshmi Vilas Bank started its operations as DBS Bank last week. On Thursday, 26 November, the private bank said that it had written off all its Basel III compliant Tier-2 bonds worth Rs. 318 crores following the advice of the Reserve Bank of India (RBI). The merger with DBS Bank was arranged by RBI, it has also written off all the equity capital of LVB as part of the merger.

Experts believe that the decision of LVB could increase the cost of borrowings of peers, especially the weaker ones. For investors, this is setting a criterion that Tier-2 bonds can also be wiped out like the Additional Tier-1 bonds of Yes Bank, which was written off earlier this year. Ajay Manglunia, managing director and head at JM Financial Products, said that weaker banks, especially private banks, would find it difficult to raise Basel III Tier-2 bonds. These bonds have a loss absorption clause, as per Section 45 of the Banking Regulation Act, RBI can take appropriate action when the bank is at a point of non-viability. The point of non-viability is determined by RBI, at this point, the bank would no longer remain a going concern and appropriate measures are required to revive its operations.

Investors tend to ignore this risk because they never understood that Tier-2 bonds are not on par with deposits. He added that the decision came as a huge surprise and shock to people who put their money in these instruments and low rated private sector banks will now find it difficult to get investors for their perpetual and Tier-2 bonds. Prakash Agarwal, director and head of financial institutions at India Ratings and Research, also said LVB’s decision could be seen as setting a precedent, since many investors, especially non-institutional ones, failed to see the difference in the risk profile of Tier-2 bonds and deposits. This could lead to an increase in the spread of Tier-2 instruments of stronger banks and weak, mid and small private sector banks. The impact would be reflected even in small and weak PSU banks as well.

Earlier this year AT-1 bonds of Yes Bank worth Rs. 8,415 crore were written off. On 16th September 2020, RBI governor, Shaktikanta Das, said that since small depositors, middle-class depositors and retired citizens depend heavily on bank deposits the primary concern of the bank must be to protect deposits.

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