Why in the news?

  • The banking sector is projected to raise nearly ₹25,000 crore through Tier II bonds in the ongoing financial year.

Tier II Bonds

  • What is it?:
    • Tier II Bonds are debt instruments issued by banks to augment their Tier II capital, which forms part of their regulatory capital under the Basel III norms.
    • They help strengthen the capital adequacy of banks.
  • Key Features:
    • Tenure: Minimum 5 years; usually between 10–15 years.
    • Callable: Can be called back by the bank after 5 years, with RBI approval.
    • No Put Option: Investors cannot demand early repayment.
    • Subordinated Debt: In liquidation, claims are settled after other creditors but before equity holders.
    • Interest Rate: Higher than normal bonds due to higher risk.
    • Listed Instruments: Can be traded in the secondary market.
    • No conversion into equity (unlike AT1 bonds).
    • Tier II Bonds fall under the Loss Absorption Capital category.
  • Regulation:
    • Governed under Basel III Capital Regulations and issued by banks under the RBI’s guidelines.
    • Qualify as Tier II capital for CRAR (Capital to Risk-Weighted Assets Ratio).
  • Benefits:
    • To Banks:
      • Helps maintain CRAR.
      • Lower cost of capital vs equity.
      • Regulatory flexibility.
    • To Investors:
      • Higher returns than government securities.
      • Relative safety vs AT1 bonds (not perpetual).
  • Risks:
    • Interest rate risk due to long tenure.
    • Liquidity risk in secondary markets.
    • Credit risk if the bank faces stress.
    • Subordinated nature: Repayment risk during liquidation