ET in a Classroom: Perpetual Bond
As the name suggests, these are bonds which do not have any maturity date and are hence perpetual.
By ET Bureau |
What is a perpetual bond?
As the name suggests, these are bonds which do not have any maturity date and are hence perpetual. Since they are never redeemed, such debt instruments give the issuers the comfort that equity capital offers in their capital base. Hence treated as equity by issuers, particularly the banks. Even regulators allow them to treat such bonds as a part of a bank’s tier-I capital, which traditionally comprise equity instruments. (While tier-II capital of a bank comprises debt instruments). But on the flip side, unlike equity, they have to be serviced perpetually by way of paying interest to the subscribers of such bond.
Who are the issuers of such bonds?
Globally, such bonds are issued essentially by entities in need of very long-term funds such as the government, banks and other financial intermediaries. But in India, it is an innovative instrument that the Reserve Bank of India allowed them to do a few years ago because of its equity like features, and are allowed to be treated as tier-I capital.
Why is it relevant in India?
After RBI stipulated banks to migrate to Basel-II or the new international bank supervisory practice, capital requirements of Indian banks went up. Allowing only pure equity instruments may not be adequate for banks. Hence, banks were allowed to raise perpetual bonds to meet their capital requirements. However, there is a growing debate that only pure equity and net worth should qualify as tier-I in the future.
What are the features of such bonds in India?
In India, innovative perpetual debt instruments presently qualify as tier-I capital. They can be issued as bonds or debenture in the local currency and the amount raised through such instruments is to be decided by the bank’s board. They can comprise up to 15% of a bank’s tier-I capital after deduction of goodwill and intangible assets, but before investments. Excess amounts raised will be eligible for tier-II capital. Such bonds can be called back by the issuer after a supervisory approval.
As the name suggests, these are bonds which do not have any maturity date and are hence perpetual. Since they are never redeemed, such debt instruments give the issuers the comfort that equity capital offers in their capital base. Hence treated as equity by issuers, particularly the banks. Even regulators allow them to treat such bonds as a part of a bank’s tier-I capital, which traditionally comprise equity instruments. (While tier-II capital of a bank comprises debt instruments). But on the flip side, unlike equity, they have to be serviced perpetually by way of paying interest to the subscribers of such bond.
Who are the issuers of such bonds?
Globally, such bonds are issued essentially by entities in need of very long-term funds such as the government, banks and other financial intermediaries. But in India, it is an innovative instrument that the Reserve Bank of India allowed them to do a few years ago because of its equity like features, and are allowed to be treated as tier-I capital.
Why is it relevant in India?
After RBI stipulated banks to migrate to Basel-II or the new international bank supervisory practice, capital requirements of Indian banks went up. Allowing only pure equity instruments may not be adequate for banks. Hence, banks were allowed to raise perpetual bonds to meet their capital requirements. However, there is a growing debate that only pure equity and net worth should qualify as tier-I in the future.
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What are the features of such bonds in India?
In India, innovative perpetual debt instruments presently qualify as tier-I capital. They can be issued as bonds or debenture in the local currency and the amount raised through such instruments is to be decided by the bank’s board. They can comprise up to 15% of a bank’s tier-I capital after deduction of goodwill and intangible assets, but before investments. Excess amounts raised will be eligible for tier-II capital. Such bonds can be called back by the issuer after a supervisory approval.
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