The government’s recent proposal to infuse capital in four state-owned banks through non-interest-bearing (zero coupon) bonds will improve the lenders’ capital levels, but not their tangible equity to a large extent.
The government notified that it has infused Rs 14,500 crore into four banks – Bank of India, Indian Overseas Bank, Central Bank of India and UCO Bank.
Indian Overseas Bank and Central Bank of India are reportedly among the four PSBs that are proposed to be privatised this year.
Zero-coupon bonds
A zero-coupon bond is a bond that pays no interest and trades at a discount to its face value.
Issued at a deep discount to the face value, these bonds are non-interest bearing, which means it is an investment that does not earn any returns, but depreciates in value over the years.
As these special bonds are non-interest bearing and issued at par to a bank, it would be an investment, which would not earn any return but rather depreciate with each passing year.
The bonds–with a tenure of 10-15 years–can be held by banks in the held-to-maturity category, insulating them from the impact of marked-to-market valuations.
Weak buffers
The agency said these long-tenure securities would be factored at par value rather than the discounted value in the banks’ balance sheet.
According to the agency, the four lenders have weak tangible buffers or a weaker ability to build and maintain capital buffers.
“Ind-Ra believes the intrinsic net worth of these instruments could be lower by more than 50% at the outset than similar maturity government papers in the market. The illiquid, non-trading nature of these securities could add to the discount,” it said in a release.
Tangible common equity is a measure of physical capital, used to evaluate banks’ ability to deal with losses. The long-tenor securities would be factored in at the face value and not the discounted value in the banks’ balance sheet.
Equity level
It said the proposed quantum of capital infusion varies between 11 per cent and 44 per cent of the tier-I capital of the respective PSBs as of the third quarter of the financial year 2020-21.
Equity level is an important factor in the banks’ ability to service Basel-III additional tier-I and tier-II bonds, it said.
“While the quantum of these instruments is limited in the total equity profile of most of these PSBs, the notching down for their tier-II bonds and additional tier-I bonds from the long-term issuer ratings and the standalone rating, respectively, could widen,” it said.
The first capital infusion through non-interest-bearing bonds was in Punjab and Sindh Bank (P&SB) in the third quarter of the financial year 2020-21.
The government has already allocated Rs 20,000 crore for equity infusion into PSBs in their Union Budget 2021-22.
The agency said it will continue to closely track these infusions and their impact on the banks’ franchise, adjusted networth and book value, it said.
The capital infusion
On Wednesday, the government infused Rs 4,800 crore into Central Bank of India, Rs 4,100 crore into Indian Overseas Bank, Rs 3,0000 crore into Bank of India, and Rs 2,600 crore into UCO Bank. The first such infusion was of Rs 5,500 crore in Punjab & Sind Bank in December.
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