Mumbai: The insurance regulator allowed insurers on Wednesday to invest in so-called additional tier 1 (AT1) bonds sold by banks, but the stiff terms set by the regulator mean many banks won’t be able to make the grade.
AT1 bonds are perpetual bonds with debt-like and equity-like features issued by banks to augment their tier 1 capital.
Insurance firms can invest in AT1 bonds of only those banks with at least an ‘AA’ rating, according to an Insurance Regulatory and Development Authority of India (IRDA) circular on 30 November.
Also, insurers won’t be able to invest more than 10% in any such issue, nor can they invest in banks which haven’t declared dividend in the last two years.
Insurers must also ensure that banks’ Common Equity Tier 1 (CET 1) capital—including the capital conservation buffer of banks—is 1% more than the prescribed minimum CET 1 capital, the circular added.
According to RBI regulations, banks must have CET 1 capital of 6.12% by March 2016 and 6.75% by March 2017. This, along with a capital conservation buffer of 1.5%, will take CET of banks to 7.625% and 8.25%, respectively.
Since these are perpetual bonds with an equity element, AT1 bonds will form part of equity investments of insurers in banks, currently capped at 15% of total investments.
Insurers also cannot invest in bonds sold by banks which come under the same promoter group or act as corporate agents of the insurer.
Bankers welcomed the move, but said the regulations limit the number of banks eligible to attract investments.
“AT1 bonds are privately placed with a single investor currently. But the new regulations demand that these bonds be listed on exchanges and insurance companies invest only 10%, which would mean that banks have to call for bidding from several investors and do a price discovery for these bonds,” said N.S. Venkatesh, executive director at Lakshmi Vilas Bank.
Under the new regulations, only State Bank of India (SBI) and Union Bank of India among public sector banks will be eligible to sell these bonds to insurers.
Private sector banks are in a better position.
So far this year, state-run banks have raised Rs24,000 crore via these bonds in the domestic market; SBI has raised Rs500 crore via an international issuance.
“The regulation is a step in the right direction. But it wants to ensure that insurance companies invest in bond issuances of stronger players since these are risky instruments. These regulations will allow banks to have new set of investors in AT1 bonds,” said Karthik Srinivasan, senior vice president, at ratings company ICRA Ltd.
ICRA had issued a warning in August this year that many state-run banks face the risk of default on coupon repayments on AT1 bonds due to the mounting losses and fall in revenue reserves. While 13 out of 21 PSU banks reported losses last year, this year too saw seven banks reporting losses in the first quarter and five in the second quarter.