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CARE Ratings has revised the ratings of AT I Bonds of four public sector banks including Canara Bank, Indian Bank, Punjab National Bank and Union Bank of India. It considered the strengthening in the overall credit profile of the banks including improvement in capital cushions over the minimum regulatory requirement, improvement in both profitabilities as well as the distributable reserves position.

While rating instruments are issued by public sector banks (PSB), CARE Ratings assigns high weightage to support from the Government of India (GoI) due to its majority shareholding and the systemic importance of these banks in the Indian financial system.

Considering the significant size and financial franchise of the banks, a default by a PSB would have material economic consequences for the government as well as regulators, hence, the importance of PSBs for GOI and the economy as a whole cannot be undermined. Additional Tier I (AT I) Bonds are perpetual debt instruments that banks are allowed to raise under the Basel III capital framework and form a part of Tier I capital for banks. These instruments have several unique features, which make them very different from other types of debt instruments and provide them equity.

The issuing bank has full discretion over coupon payments at all times on these instruments. Therefore, if a bank does not have sufficient distributable reserves to service the coupon on AT I Bonds, it may not pay the coupon. These bonds also have loss-absorption features through conversion/writedown/ write-off on breach of pre-specified trigger on capitalisation requirement or at the point of non-viability (PONV) which may be decided by the Reserve Bank of India (RBI).

As per CARE Ratings’ criteria for rating of hybrid instruments issued by banks, CARE Ratings has been notching down the AT I Bonds issued by the banks by one to several notches below the Tier II Bonds rating depending on the expected adequacy of eligible reserves, cushion over minimum regulatory capital and other credit risk assessment parameters of the individual bank to factor in the additional risk in these instruments on account of several unique features.

In the last few years, PSBs have received significant government as well as regulatory support. GOI has initiated consolidation of the sector by amalgamation of relatively weaker and smaller banks into anchor banks which have gained significant scale increasing their economic and systemic importance and has further recapitalised these banks.

“With the strengthening of the resolution of NPAs under the Insolvency and Bankruptcy Code (IBC) process, the banks have seen recoveries in some of the large NPAs. The banks also have made higher provisioning on bad assets and additional provisioning in anticipation of expected losses due to Covid-19 which has increased the provision coverage ratio (PCR) and provided strength to the balance sheets of these banks,” the rating agency said.

“Further, instances of GOI and regulatory support by way of broadening of the definition of distributable reserves to include more categories of reserves as distributable reserves and allowing accumulated losses to be set-off against the share premium account which has increased the ability of PSBs to service the coupons of AT I Bonds, reiterate that the stance to extend support even to hybrid instruments. PSBs are expected to receive capital support well in advance so that the coupon payment trigger is not breached in future,” it added.