Revised Basel regulations reduce risk of Tier I instruments

Reserve Bank of India's (RBI) revised guidelines on Basel III capital regulations released yesterday will help in reducing risks on non-equity Tier I instruments and also make the
issuances of such instruments more attractive for investors., says ratings agency Crisil.

These measures will, therefore, reduce the cost of issuance for banks.

The risk of coupon non-payment now stands reduced, under the revised guidelines. This is because banks can now use their past reserves to pay coupon on these instruments, while the earlier guidelines had restricted banks to pay coupon only from current year profits.

Says Rajat Bahl, director, Crisil Ratings,  ''We will now understand the bank's policy towards building sufficient cushion in the form of free reserves as it will be an important factor that can help reduce the risk of coupon non-payment for Tier I instruments''.

Further, the revised guidelines make the instruments more attractive for investors. Banks are now also permitted to temporarily write-down non-equity tier I instruments (vis--vis permanent write down or conversion to equity as per the earlier guidelines) in case their equity capital breaches the pre-specified trigger of 6.125 per cent.

Further the banks have an option to call the non-equity Tier I instruments after five years, thereby, reducing the maturity of the instrument from a compulsory ten years under the earlier regulations.

Although the revised guidelines reduce the risks to the investor, Basel III non-equity Tier I instruments will continue to remain riskier as compared to Tier II instruments and non-equity Tier I instruments under Basel II.

This is due to the continued presence of riskier features like coupon discretion, high capital thresholds for likely coupon non-payment, and principal write-down in case equity capital breaches the pre-specified trigger.

According to Pawan Agrawal, senior director, Crisil Ratings, ''Crisil's ratings on non-equity Tier I instruments under Basel III will continue to be notched-down from the corporate credit rating (CCR) of the bank. The extent of notch-down, however, is now expected to be lower than that under the earlier guidelines given the reduced riskiness due to the revised guidelines''.