* Investors shun new style subordinated debt
* Lack of understanding, tight pricing blamed
* Banks need INR5trn in capital by 2018
By Manju Dalal
Dec 7 (IFR) - A lack of interest from investors is
threatening to derail the efforts of Indian banks to raise the
additional capital they need to comply with tougher Basel III
The first sales of Basel III-complaint subordinated bonds
flopped after a resounding rejection from investors. Now,
bankers are unsure if any institution will be able to muster
demand for the new products for at least the next six months.
"We tried, but the only reaction we got from investors was:
'Basel III - what kind of animal is this'?" said the head of
debt capital markets at a private sector bank.
His bank attempted to sell a new-style sub bond last week,
but was eventually forced to revert to the tried-and-tested
Basel II structure - even though it will lose 10% of the capital
benefit from the notes each year from January 1, when Basel III
rules kick in.
Central Bank of India, Oriental Bank of Commerce, United
Bank of India and even ING Vysya Bank have all tried and failed
to sell Basel III-compliant bonds in the past few weeks.
The Indian banking sector may be among the most in need of a
capital boost under the new Basel III regime. Yet, it is
becoming clear that it is also one of the least prepared for the
If local markets continue to be unavailable for fundraising,
banks may need either to pay up to access overseas capital or
shrink their loan books.
"The transition to Basel III is not coming at a good time
for Indian banks as they are facing asset-quality issues and the
overall business outlook looks grim," said another banker.
There are several hurdles to these new bonds in India, not
least being the lack of understanding on the buy side.
The loss-absorption features required for sub bonds to count
towards Basel III capital may put the paper beyond the reach of
investors like pension funds and insurance companies, if their
funds are not allowed to invest in equities.
To qualify as additional Tier 1 or Tier 2 capital, bonds
will need to write down to zero if the RBI deems a bank to be
non-viable, forcing sub bondholders to wear losses before any
public funds are used in a bail-out.
This feature means credit ratings on the Basel III-compliant
instruments will also be lower than investors are accustomed to
on the old-style notes, making the new ones inaccessible to some
institutional investors with statutory limitations to invest
only in debt rated Double A or above.
Then, there is the price issue.
"Under Basel III guidelines, perpetual bonds will need to
have a loss-absorption clause, which implies higher risk for
investors in these instruments. Investors will need to be
compensated for the increased risks by offering higher coupons
on these instruments," said Pawan Agrawal, senior director,
Price-sensitive Indian issuers are still not ready to face
that reality. For instance, United Bank of India, rated AA
(Crisil), had pitched a Basel III-compliant Tier 1 perpetual to
investors at a price in line with the old-style bonds.
After investors pushed back, the lender eventually priced
the issue under the old-style Basel II format on November 30.
The bank raised INR3bn from perp bonds, callable after 10 years,
After January 1, banks like UBI will have no such fallback.
Without a loss-absorption clause, no new bonds will count
towards Tier 2 or Tier 1 capital once the Basel III deadline
Even though lobbyists have asked the regulator to delay the
implementation of Basel III, the Reserve Bank of India is not
"RBI considers itself flag bearer of changes and it does not
care if the markets are ready for these changes," said another
Under its version of Basel III, the central bank will
require lenders to hold a minimum common equity ratio of 8% and
a minimum total capital ratio of 11.5%. RBI estimates that
Indian banks will need to raise INR5trn (USD91.8bn) before March
2018 to comply with the tougher capital requirements.
Public sector lenders will receive some of the additional
equity from the government, but the RBI expects nearly
INR3.25trn to come from the bond markets in the form of non-core
That figure matches estimates from local rating agency,
Icra, which estimated in May 2012 that Indian banks would be
required to issue INR1.9trn of additional Tier 1 of and INR1trn
of Tier 2 capital.
As a result, market participants are saying that Basel III
will be a catalyst for a major consolidation in the industry as
many weaker banks will not be able to meet the RBI's more
(Reporting By Manju Dalal; Editing by Steve Garton and