Version 1 of recap bonds yet to mature

market
This is not the first time that recapitalisation bonds have been used by the government to help capital-starved banks. The previous bonds, going by recent Budget documents, have not yet matured.

The annexure of the receipts budget for 2017-18 shows the outstanding against old ‘special securities issued to nationalised banks converted into marketable securities’ was at Rs 20,808.75 crore. These were the first version of recapitalisation bonds, issued in the 1990s, that the government is using again to rescue banks. 

Most of these old bonds are maturing through 2022 to 2032, indicating the original maturity profile of these bonds were as high as 30-37 years. But these were converted in 2007 as dated securities of 15 to 25 years.  

Yet, at a massive Rs 1.35 lakh crore this time, the bond market is not complaining of the government potentially breaching its fiscal deficit target of 3.2 per cent.

State Bank of India’s Deputy Managing Director for Global Markets Venkat Nageswar said “the recapitalisation bonds are cash neutral.” 

The Government of India, or a special purpose vehicle, would issue bonds that would be subscribed to by the banks. The proceeds would then be transferred as capital to public sector banks, and therefore, the market has no reason to worry, he said.

On banks’ books, the bonds would sit on the asset side, and equity will be the liability. On government’s books, the bonds would be a liability and the bank stake would be assets. 

“We are requesting the bonds to be given SLR status and be repo-able,” Nageswar said.

SLR or statutory liquidity ratio status indicates a bonds’ eligibility to be calculated under the mandatory bond-holding limit of banks. If a bond has SLR status, it can be used in repo operations, or be mortgaged with the Reserve Bank of India (RBI) for funds.

Jayesh Mehta, head of treasury at Bank of America-Merril Lynch, said the beauty of deposits getting converted to equity was that banks can now leverage the money multiple times through lending. “It’s all for a good cause. The RBI governor himself has cheered the move and this has assured the market. The market can see these bonds can actually lift the economy and, therefore, there is not going to be any complaint.”

The yields on the 10-year bonds rose six basis points to 6.81 per cent from its previous close of 6.75 per cent. 

In the 1990s, the government had for the first time issued recap bonds worth Rs 20,000 crore. The problem then was priority sector loan obligations, which were rarely paid back to banks. The problem this time is corporate assets turning bad on bank books.

The bonds issued earlier were not for trading. But in fiscal year 2007, the government decided to make these bonds tradable. 

According to market sources, banks were never able to trade these bonds as liquidity was scant. Lenders incurred heavy mark-to-market losses on these papers and the “modified duration” of these bonds were a major headache for banks. Modified duration is the perceived change in valuation of a bond in response to change in interest rate. 

In many ways, the story is the same with any illiquid bonds. But banks have an option to move other papers in the held-to-maturity (HTM) category once a year. In HTM category, a bank doesn’t need to value its fixed income based on the current market price. 

Once the bonds are put in HTM, banks generally remove those only after maturity. Since the recap bonds were a direct issuance by the government, banks were not sure what to do with these. Finally, in 2015, the RBI allowed banks to put these bonds back in HTM category, much to the relief of bankers. 

“In terms of RBI guidelines, banks are allowed to keep recapitalisation bonds in the HTM portfolio according to their discretion. HTM categorisation for these bonds would prevent banks from volatility on account of MTM effects,” Nageswar said. 

According to some finance ministry officials, this time, too, the bonds would be non-marketable initially. 

This would ensure these doesn’t cause disruption in the bond markets. The bonds might be converted into trading instruments later on.

THE BOND STORY
  • The outstanding against old ‘special securities issued to nationalised banks converted into marketable securities’ was at Rs 20,808.75 crore
  • These were the first version of recapitalisation bonds, issued in the 1990s, that the government is using again to rescue banks
  • Most of these old bonds are maturing through 2022 to 2032
  • The original maturity profile of these were as high as 30-37 yrs
  • These were converted in 2007 as dated securities of 15 to 25 yrs
  • The yields on the 10-year bonds rose 6 bps to 6.81 per cent from its previous close of 6.75 per cent

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