Zero coupon bonds will bring no tangible gains to PSU banks

sMUMBAI: The government’s decision to infuse capital into public sector banks (PSBs) through non interest bearing zero coupon bonds will help the banks to meet regulatory requirements but will not strengthen the tangible equity of these banks. Issued at a deep discount to the face value, these bonds are non-interest bearing which means it is like an investment that does not earn any return but depreciates in value over the years.

Prakash Agarwal, head financial institutions at IndiaRatings (Ind-Ra) said the value of these instruments is half of the government bond paper of a similar maturity.

“Typically a bond earns interest but since these are not earning any interest the value of Rs 100 invested today is actually lower than that invested in a government security of a similar maturity,” Agarwal said.

On Tuesday the government notified capital infusion totalling Rs 14500 crore through these bonds in Central Bank of India, UCO Bank, Bank of India and Indian Overseas Bank. It followed a similar Rs 5500 crore infusion in Punjab and Sindh Bank in the quarter ended December. The Reserve Bank of India (RBI) had then flagged concerns on these instruments due to the ambiguity around the valuation of these instruments. It is unclear whether the finance ministry has addressed the central bank’s concerns before issuing these bonds.

The valuation of this equity infusion is also important as these banks are likely candidates for a likely sale this fiscal.

In a note Ind-Ra said the zero coupon nature of these instruments along with the illiquid, non-trading nature of these securities could add to its discount.

“Equity levels is an important factor in the banks’ ability to service Basel III Additional Tier 1 and Tier 2 bonds. 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,” Ind-Ra said.

Typically, the government issues capital through the money raised by the paper subscribed by the same PSU banks. But these earn interest on these bank’s balance sheets. With the zero coupon bonds the banks will not benefit from that income.

Since fiscal 2018 the government has used recapitalisation bonds with banks subscribing to the bonds with a maturity ranging between 10 to 15 years and coupon rates of 7.4 per cent-7.7 per cent. The government would then use the funds raised to be infused back in PSBs as equity. PSBs would hold these securities in their investment portfolio under the held-to-maturity category. The government paid Rs 5800 crore in interest payments on these bonds in fiscal 2019 and Rs 16,209 crore in fiscal 2020, Ind-Ra said.

“Assuming a 6 per cent yield on the total Rs 20,000 crore infused by the government in fiscal 2021, banks could lose Rs 1200 crore in interest. The fact is that these banks will benefit from the capital infusion but will have to bear the costs of holding these instruments in their books,” said Karthik Srinivasan, group head financial sector ratings at ICRA.

The government has allocated another Rs 20,000 crore for equity infusion in these lenders for the current fiscal ending March 2022. It remains to be seen whether the government continues with these instruments to infuse capital and yet save on any interest outgo on the fisc.

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