Vignesh Iyer

Basel III capital regulations are yet to be fully implemented.  Total regulatory capital for Banks comprises of Tier 1 capital (Common Equity Tier 1 and Additional Tier 1) and Tier II capital. RBI has come up with yet another amendment widening the scope of ‘Distributable Items’ for making the coupon payments in case of Perpetual Debt Instruments (PDIs), an instrument qualifying as Additional Tier 1 (AT 1) under the Basel III Capital Regulations.

The Master Circular on Basel III Capital Regulations (Master Circular) provides the guidelines based on the Basel III reforms on capital regulation on May 02, 2012 for regulating the capital and ratio requirements. Annexure 4 of the said Master Circular provides the criteria for inclusion of PDIs issued as bonds or debentures by Indian banks in AT 1 capital.

Para 1.8 (e) of Annexure 4 specifies the criteria for Coupon Discretion with regard to the issued PDIs. Initially, coupon on PDIs could not be paid out of retained earnings/ reserves. Thereafter, RBI had issued a clarification circular dated January 14, 2016 (January Circular) rewording the said Para enabling payment out of revenue reserves, excluding such reserves created for specific purposes by a bank, and out of credit balance in profit and loss account, if any. However, payment  out of revenue reserves was subject to  issuing bank meeting minimum regulatory requirements for CET1, Tier 1 and Total Capital ratios at all times and subject to the requirements of capital buffer frameworks (i.e. capital conservation buffer, counter cyclical capital buffer and Domestic Systemically Important Banks).

Present amendment

On February 02, 2017 RBI issued another circular (February Circular) amending Para 1.8(e) of Annex 4. RBI has now permitted the Banks to pay out of their statutory reserves (excluding certain items mentioned in the later part of the write-up), which was previously permitted only out of revenue reserves not created for specific purpose by a bank, to pay the coupons to the PDI holders subject to the following procedure:

Step 1: The Bank has to calculate the aggregate value as per the following:

Particular Amount
Profits in the Current year XXX
Add: Profits brought forward from the previous years XXX
Add: Permissible reserves  excluding statutory reserves XXX
Less: Accumulated losses and Deferred revenue expenditure XXX

Step 2: Estimate the total amount to be paid as coupon to the PDI holders

Step 3: If the amount estimated under Step 1 > Step 2, then the Bank shall not make any appropriation from the Statutory Reserves.

This makes it clear that though the appropriation from Statutory Reserves for coupon payments to PDI holders is permitted, the same has not been permitted as an outright right. Further, it shall also be noted that payment of coupons on PDIs from the reserves is subject to the issuing bank meeting minimum regulatory requirements for CET1, Tier 1 and Total Capital ratios including the additional capital requirements for Domestic Systemically Important Banks at all times and subject to the restrictions under the capital buffer frameworks (i.e. capital conservation buffer and counter cyclical capital buffer in terms of Para 15 and 17 respectively of the Master Circular.

Also any bank proposing to appropriate any sum or sums from the reserve fund or the share premium account shall within twenty-one days from the date of such appropriation, report the fact to the Reserve Bank explaining the circumstances relating to such appropriation as required under Para 2 of the Circular dated September 20, 2006 issued by RBI on ‘Section 17 (2) of Banking Regulation Act, 1949 – Appropriation from Reserve Fund’. But RBI vide Para 3 of the same circular had advised to take prior approval before making any such appropriations.

However, vide the February Circular RBI has waived off the requirement of such prior approval if any appropriation from the Reserve Fund is made for paying the coupon to PDI holders in accordance with the guidelines specified in the said circular.

The condition imposed under Para 1.8(e) of Annex 4 under all three scenarios is tabulated as under:

Scenario 1 – Master Circular Scenario 2 – Re-worded vide January Circular (Present)Scenario 3 – As Amended vide February Circular
“Coupons must be paid out of distributable items. In this context, coupon may be paid out of current year profits. However, if current year profits are not sufficient i.e. payment of coupon is likely to result in losses during the current year, the balance amount of coupon may be paid out of revenue reserves (i.e. revenue reserves which are not created for specific purposes by a bank) and / or credit balance in profit and loss account, if any.

However, payment of coupons on PDIs from the revenue reserves is subject to the issuing bank meeting minimum regulatory requirements for CET1, Tier 1 and Total Capital ratios at all times and subject to the requirements of capital buffer frameworks (i.e. capital conservation buffer, countercyclical capital buffer and Domestic Systemically Important Banks).

Banks must ensure and indicate in the offer document that they have full discretion at all times to cancel distributions / payments in order to meet the eligibility criteria for perpetual debt instruments.”

“Coupons must be paid out of distributable items. In this context, coupon may be paid out of current year profits. However, if current year profits are not sufficient, coupon may be paid subject to availability of sufficient revenue reserves (those which are not created for specific purposes by a bank) and / or credit balance in profit and loss account, if any.

However, payment of coupons on PDIs from the revenue reserves is subject to the issuing bank meeting minimum regulatory requirements for CET1, Tier 1 and Total Capital ratios at all times and subject to the requirements of capital buffer frameworks (i.e. capital conservation buffer, countercyclical capital buffer and Domestic Systemically Important Banks).

Banks must ensure and indicate in the offer document that they have full discretion at all times to cancel distributions / payments in order to meet the eligibility criteria for perpetual debt instruments.”

“Coupons must be paid out of ‘distributable items’. In this context, coupon may be paid out of current year profits. However, if current year profits are not sufficient, coupon may be paid subject to availability of:

(i) Profits brought forward from previous years, and/or

(ii) Reserves representing appropriation of net profits, including statutory reserves, and excluding share premium, revaluation reserve, foreign currency translation reserve, investment reserve and reserves created on amalgamation.

The accumulated losses and deferred revenue expenditure, if any, shall be netted off from (i) and (ii) to arrive at the available balances for payment of coupon.

If the aggregate of: (a) profits in the current year; (b) profits brought forward from the previous years and (c) permissible reserves as at (ii) above, excluding statutory reserves, net of accumulated losses and deferred revenue expenditure are less than the amount of coupon, only then the bank shall make appropriation from the statutory reserves. In such cases, banks are required to report to the Reserve Bank within twenty-one days from the date of such appropriation in compliance with Section 17(2) of the Banking Regulation Act 1949.

It may be noted that prior approval of the Reserve Bank for appropriation of reserves as above, in terms of the circular, DBOD.BP.BC No.31/21.04.018/2006-07 dated September 20, 2006 on ‘Section 17 (2) of Banking Regulation Act, 1949 – Appropriation from Reserve Fund’ is not required in this regard.

However, payment of coupons on PDIs from the reserves is subject to the issuing bank meeting minimum regulatory requirements for CET1, Tier 1 and Total Capital ratios including the additional capital requirements for Domestic Systemically Important Banks at all times and subject to the restrictions under the capital buffer frameworks (i.e. capital conservation buffer and counter cyclical capital buffer in terms of paras 15 and 17 respectively of the Master Circular on Basel III Capital Regulations dated July 1, 2015 as amended from time to time).

In order to meet the eligibility criteria for perpetual debt instruments, banks must ensure and indicate in their offer documents that they have full discretion at all times to cancel distributions / payments.”

Conclusion

The current amendment expands the scope of the Banks to source out funds for paying the coupons to the PDI holders. Waiving off the requirement of prior approval of RBI for any appropriation made from Reserve Funds makes the amendment much more relevant. This may provide a positive effect for both the Banks and the potential investors who may want to invest in PDIs. Hope with such relaxations available, the financial sector may see multiple Banks coming forward with issuance of PDIs for raising AT 1 capital.

(Author is associated with Vinod Kothari & Co. and can be reached at vignesh@vinodkothari.com)

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