To start the year, Indian lenders have sold almost US$6 billion worth of “Additional Tier 1” contingent bonds, which can be written down in the event capital falls short. That compares with almost no such issuances in the previous 12 months.
Una Galani writes for Reuters Breaking Views that if losses trigger the clause which forces banks to suspend dividends for these bonds, investors could flee.
“In theory, missed coupons and writedowns should be signs the bonds are working as designed. However, the risk is that investors – including insurers and pension funds – respond by fleeing the asset class”, Galani writes.
“At worst, the loss of confidence might lead to a flight of deposits. Though that sounds extreme, Indian state banks have a reputation for always paying their dues, so no one really knows how the market would react.
“Either way, the assumption that the state will support instruments designed to enforce market discipline sets the scene for trouble.”