InvestorQ : With Lakshmi Vilas Bank writing off its debt to bond holders, do you see an impact on the borrowing cost for smaller banks?
Dawn Cherian made post

With Lakshmi Vilas Bank writing off its debt to bond holders, do you see an impact on the borrowing cost for smaller banks?

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Mitali Bhutta answered.
8 months ago
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You are actually correct. The decision by Lakshmi Vilas Bank to write down Tier-2 bonds worth Rs.318 crore is likely to sharply increase the cost of borrowing for peers. The weaker banks are more vulnerable to higher cost funds as investors now perceive more risk in lending to such banks.

Under instructions from the RBI, LVB was forced to write down all of its Basel III compliant Tier-2 bonds prior to the merger with DBS Bank India. This comes after the RBI had already written off the equity capital and the free reserves of LVB. Coming on top of the Yes Bank write-down of AT1 bonds of Rs.8415 crore, it has increased risk perception.

In a way, the markets are seeing this decision of the write-down of Tier-2 bonds as a signal that the central bank would not hesitate to load the losses on the bond holders and the shareholders to protect the interests of the deposit holders. After all, these Tier-2 bonds can also be fully written off under Section 45 of Banking Regulation Act like AT1 bonds.

Going ahead, experts feel that weaker banks that are stretched on capital adequacy and NPA provisions are likely to face problems raising funds in the secondary market, especially through AT1 bonds and Tier2 bonds. That risk was ignored hoping that banks would eventually do a full rescue of beleaguered banks. But that is not the case.

While many small and medium sized investors never understood that risk, the larger institutions that understood chose to ignore the reality of this risk actually translating into losses. That element of disdain was evident in the Yes Bank case and again in the LBV case. Smaller banks may have problems selling AT1 and Tier 2 bonds.

However, investors cannot say there were not warned because CARE had downgraded these Tier-2 bonds of LBV in October precisely for this possibility that they could be written off. CARE had warned that LVB was approaching non-viability and hence ran a huge risk. To that extent, LVB Tier-2 bonds will be seen as a precedent.

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