Yes Bank's AT1 bonds write-off smacked of negligence by RBI

The Bombay High Court has quashed the write-off of Additional Tier-1 (AT1) bonds worth ₹8,400 crore issued by Yes Bank Ltd, bringing relief to investors. A total of seven writ petitions were filed against Yes Bank, including four institutional petitions and three by individual investors.

The decision will have far-reaching implications as other banks also have AT-1 bonds in their balance sheets. Recently, State Bank of India issued AT1 bonds worth ₹6,872 crore. Bank of India is going to issue AT1 bonds for ₹1,500 crore this fiscal. 

Let us analyse the issues involved.

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What are Additional Tier 1 bonds?

AT1 bonds are unsecured bonds and have perpetual tenor. Hence, they do not have any maturity date. However, they can have a call option. So, the issuer can buy back the bonds from the holders. The bonds are used by the banks to improve upon their Tier 1 capital.

AT1 bonds are subordinate to all other debt and only senior to common equity.

Yes Bank’s AT1 bonds

Yes Bank issued the following AT1 bonds: On December 31, 2013 for ₹280 crore at interest of 10.5 per cent; on December 23, 2016 for ₹3,000 crore at interest of 9.5 per cent; and on October 18, 2017 for ₹5,415 crore at interest of 9 per cent.

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All these bonds are unsecured, non-convertible, Basel III compliant AT1 subordinated bonds in the nature of debentures.

Mis-selling of bonds

Typically, the investors of these bonds are institutions that clearly understand the terms and conditions and also various regulatory implications applicable. But a SEBI probe found that Yes bank had facilitated the selling of AT1 bonds from institutional investors to individual investors. The latter were not informed about all the risks involved. Yes Bank had represented these bonds as “Super FD” and “as safe as FD” to individual investors.

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SEBI also found that the push from the Managing Director of Yes Bank to down-sell the AT1 bonds led its private wealth management team to recklessly sell the bonds to individual investors. It is said that most of these individuals were senior citizens aged above 70 years and they had given their entire life savings because they were mis-sold these bonds.

Collapse of Yes Bank

In fiscal 2019-20, Yes bank saw a significant decline in its deposit base and an increase in its non-performing assets ratio, resulting in a breach of various statutory ratios. Further, the bank had also breached the RBI mandated Common Equity (CET1) ratio and Tier 1 capital ratio which in March 2020 stood at 6.3 per cent and 6.5 per cent as compared to the minimum requirements of 7.375 per cent and 8.875 per cent, respectively.

The Centre placed the bank under a moratorium on March 5, 2020 owing to its depleting financial health. The RBI allowed a write-off of ₹8,400 crore on AT1 bonds issued by Yes Bank after it was rescued by SBI. 

It is entirely a different subject to discuss how the RBI allowed the bank to collapse — the central bank was obviously not monitoring the private bank well enough, and the latter was dispensing credit recklessly with borrowed funds instead of deposit mobilised, and breaking the capital adequacy ratio.

The AT1 bonds write-off

Why was the AT1 bonds write-off not in order? There are four key reasons

1. In the respective information memorandums of the AT1 bonds, the bank stated that the claims of the AT1 bondholders “…shall be superior to the claims of investors in equity shares and perpetual non-cumulative preference shares issued by the bank”. It also provided that “the order of write-off of the bonds shall be as specified in the order of seniority as per this information memorandum”. But the bank has not written off the equity capital while writing off the AT1 bonds and hence it is contrary to issue terms.

2. These bonds were issued fulfilling Basel-III compliance. Basel III norms provide that “the write down of perpetual debt instruments shall be done subsequent to the write down of common equity capital”. Hence the write down is against Basel III norms.
3. As per the offer document of the AT1 bond issued by the bank on December 31, 2013, “all AT1 bonds issued by the bank/to be issued in future by the bank shall rank pari-passu amongst themselves and hence shall be temporarily written down (full/partial) in pari-passu”. But, on March 14, 2020, the bank wrote down only the two bonds worth ₹3,000 crore and ₹5,415 crore. Hence the write off is contrary to issue terms.
4. The government notification has not permitted the writing down of this AT1 bond in its Yes Bank Ltd Reconstruction Scheme, 2020. The bank and RBI did not follow the provisions as notified by the government and the Banking Regulations Act, 1949. Hence the write off is ultra vires and in violation of the final Scheme notified/sanctioned by the government under Section 45(7) of the Banking Regulations Act.

What next?

It is reported that Yes Bank and RBI are likely to challenge the order. If it is not challenged, the court order could put Yes Bank insolvent, putting at risk the entire investments made by banks, including SBI. But it may only help postponing the inevitable.

There seems to be gross negligence on the part of the central bank in the entire Yes Bank episode. The government cannot be a mere spectator. While the depositors and common bond holders should be helped, drastic punitive action should be initiated against officials who are responsible.