Indian offshore AT1s need regulatory freedom
Now is the time for India to tackle regulatory roadblocks to going offshore with bank capital bonds
Indian banks risk losing a golden opportunity for fundraising if a regulatory hurdle limiting their access to the offshore additional tier one (AT1) market is not loosened up rapidly.
Since August, two Indian private sector banks, HDFC Bank and Axis Bank, have ventured to the dollar market with Basel III-compliant AT1 bonds — seizing benefits of size and tighter pricing versus in the rupee market. The two firms followed State Bank of India, which sold the country’s first international AT1 in 2016, but saw no peers follow suit until this year.
The pipeline for the rest of 2021 also remains thin, with only a second-tier state lender — Union Bank of India — firming up plans for an offshore AT1 sale.
The reason for the limited deal flow is clear. The Reserve Bank of India and its regulations have the reputation of being tough and complex at the same time. But its rules get even more complicated when it comes to bank capital — bringing real meaning to the adage of the devil being in the detail.
The regulatory nuisance, buried inside the RBI’s 327-page July 1, 2015, master circular on Basel III capital regulations, allows Indian lenders to issue AT1s equal to no more than 49% of the “eligible amount” offshore.
This eligible amount was recently clarified by the central bank to be 1.5% of their risk-weighted assets (RWA).
This interpretation caps offshore AT1 issuance for even the top tier lenders at laughable numbers. For instance, SBI, the largest Indian lender by assets, only has room to issue around $2bn in new AT1s overall, say sources.
This regulatory quirk gives HDFC Bank, the largest Indian private sector lender by assets, the headroom to raise only $1.1bn in offshore AT1s. The lender printed $1bn 3.7% AT1s last month, reopening the bank capital market for the country.
Axis, meanwhile, took home $600m in a AT1 bond with a sustainable label earlier this month. Axis couldn’t print a bigger deal as it did not get the necessary approvals on time.
Yet, both HDFC’s and Axis’s offerings were hugely successful, attracting investors looking for high yielding, as well as safer, assets than what the embattled Chinese bond market could offer. As AT1s are relatively risky and lower rated than senior bank bonds, they offer a premium and can often find more buyers.
Favourable market conditions for Indian borrowers, driven by investors' hunger for yield and diversification outside of China, mean now is an opportune time for banks to issue more offshore AT1s. But the RBI rules threaten to spoil the party before it really gets started. Given just three Indian lenders have issued capital bonds offshore for a total of $1.9bn so far, there is definitely rarity value for these notes.
Investors’ eagerness for Indian AT1s was evident in HDFC and Axis’s orderbooks. Each attracted some $3.2bn at reoffer.
Banks are understood to be lobbying to get the RBI to loosen the guidelines for AT1s. Broadening funding access for lenders is critical at a time when the onshore bank capital market is struggling due to tighter norms.
Earlier this year, the Securities and Exchange Board of India issued rules tightening investment norms for onshore AT1s. The regulator’s directive followed private sector lender Yes Bank’s Rp84.15bn ($ 1.1bn) AT1 write-off last year, a landmark moment for the country’s bank capital market.
Offshore AT1s provide diversification to lenders, while also allowing them to raise larges amounts than what is possible domestically.
Although the onshore AT1 market still remains open and gives a pricing advantage of at least 1% in terms of yield, it is unlikely to meet banks’ potential needs. Banking analysts expect around $7.5bn-equivalent of onshore AT1s to be called this year and next. This is on top of fresh issuances of AT1s of an equal or higher amount.
The RBI has always pushed banks to look onshore for bank capital deals, while prioritising raising core equity.
No doubt, core equity is the best form of capital, but it has put banks in a conundrum as equity comes with a higher cost.
GlobalCapital Asia understands that the central bank is discussing a proposal to provide some relief to banks looking to go offshore for capital. But if the RBI wants to bring about some serious change, and support the banking sector, it must act quickly. Otherwise, it risks losing the market and investor momentum.