Context:
Additional Tier-1 (AT-1) bonds worth Rs. 10,000 crore at the coupon rate of 8.1% recently issued by the State Bank of India (SBI). But the issue did not get a good response by the subscribers as only Rs.3,100 crore worth of bonds were subscribed.
About AT-1:
An Additional Tier-1 (AT-1) bonds are a type of debt instrument issued by bank to raise capital. They are also known as perpetual bond because it has no fixed maturity date and can be redeemed only at the discretion of the issuer.
AT-1 bonds are considered riskier for the investors as they carry higher interest rate than regular bonds.
As they carry the features of both equity and debt, they are considered as hybrid securities.
Features of AT-1 Bonds
- AT-1 Bonds are type of unsecured, perpetual bond issued by the banks to raise the capital.
- AT-1 Bonds are like of other bonds but pay a higher rate of interest compared to others.
- These bonds are also listed and traded on the exchanges, so AT-1 bondholders can sell these bonds in the secondary market.
- AT-1 bonds don not have a fixed maturity date, they can be redeemed only at the discretion of the issuer.
- Bank issuing AT-1 bonds can skip interest payouts for a particular year or even reduce the bond’s face value.
- Investors cannot return these bonds to the issuing bank and get the money i.e. there is no put option available to its holders.
Importance of AT-1 Bonds for banks:
- AT-1 Bonds helps the banks to raise capital without diluting their equity or affecting their return on equity.
- The banks can meet the Basel III and improve their CAR through AT-1 bonds.
- The banks can maintain flexibility in managing their capital structure and interest payments.
Importance for Investors:
- AT-1 bonds provide higher interest to the investors compared to any other debt instrument.
- Investors also get the tax advantages as they are treated as equity for tax purposes.
- They provide diversification to investors’ portfolios and exposure to the banking sector.
Challenges for banks:
- Higher interest rates increase the cost of capital for banks.
- AT-1 bonds include reputational risk for banks as skipping of interest payments or triggering loss absorption can damage their image and credibility.
- They expose banks to regulatory risks as they are subject to changes in norms and rules by the regulators.
Challenges for Investors:
- Risk carried by AT-1 bonds is relatively higher than any other debt instrument, which discourage investors to invest in these bonds.
- They have lower liquidity as they have no maturity date and limited secondary market.
- They have higher volatility than any other debt instrument, as they are sensitive to changes in interest rates, credit ratings and market sentiments.
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