In recent financial news, banks are increasingly turning to Tier II bonds as a strategic means to enhance their capital base, especially at a time when companies are actively raising funds through IPOs. This year, the banking sector is projected to amass approximately ₹25,000 crore through these bonds, with ₹10,000 crore already secured.
The current surge in Tier II bond issuance is propelled by several critical factors. There is a substantial demand for long-term debt instruments, coupled with expectations of a repo rate cut in the forthcoming monetary policy, which makes present borrowing costs appealing. Additionally, regulatory obligations are prompting institutions to invest in such bonds, creating an opportune environment for banks to aggressively enter the market.
Tier II bonds are essential long-term debt instruments issued by banks to bolster their capital reserves. Typically, these bonds have a minimum tenure of five years, helping banks meet Basel III capital adequacy standards. They provide an additional cushion for future credit expansion without diluting equity, making them an effective funding mechanism.
Moreover, Tier II bonds enhance a bank’s capital-to-risk weighted assets ratio (CRAR), adding stability to its balance sheet. CRAR is a vital financial metric that evaluates a bank's capital in relation to its risk-weighted assets, reflecting its financial robustness. A higher CRAR suggests a bank's greater ability to absorb potential losses, thus promoting financial stability and safeguarding depositors.
Leading banks in India are rapidly increasing their Tier II bond issuances. Recently, SBI raised ₹7,500 crore through a 10-year bond at a competitive interest rate of 6.93%, while ICICI Bank secured ₹1,000 crore in June. Analysts predict that banks might collectively raise up to ₹15,000 crore by December.
Previously, banks had delayed such issuances due to sufficient liquidity, lower deposit rates, and anticipated future rate cuts that would reduce borrowing costs. Last year, banks accumulated nearly ₹31,000 crore through Tier II bonds, indicating a renewed interest driven by improving market conditions and the necessity to fortify their capital base.
Banks are increasingly favoring Tier II bonds due to the cost-effectiveness of long-term borrowing compared to raising funds through deposits. The corporate sector's preference for shorter-term bonds this year has led to a heightened demand for long-duration, high-quality debt, thus providing banks with a favorable window to act.
Investors are encouraged by the expectation of a repo rate cut anticipated in December, motivating them to secure long-term yields now. The scarcity of top-rated long-tenor bonds has spurred interest in Tier II issuances, with SBI’s competitively priced 6.93% bond setting a benchmark, boosting confidence among other banks. Furthermore, provident and pension funds are compelled to meet regulatory investment quotas, escalating demand for long-term corporate bonds.
Some banks are also looking to refinance older bonds whose call options have been exercised. Given the stable markets and attractive yields, banks perceive this as an ideal period to strengthen their capital buffers instead of waiting for potentially volatile conditions later in the year.
Despite their growing popularity, Tier II bonds are not the primary funding source for Indian banks. Most large banks predominantly rely on deposits for growth and capital needs. With adequate internal capital generation and sufficient buffers, the future issuance of Tier II bonds will largely depend on market attractiveness.
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