Current Affairs

Issue

Securities and Exchange Board of India (SEBI) has put certain restrictions on mutual fund (MF) investments in additional tier-1 (AT1) bonds.

 

Background

The Ministry of Finance has asked SEBI to withdraw the order as it can create disruption in the investment of mutual funds.

 

Details

• AT1 Bonds is short form of additional tier-1 bonds. These are unsecured bonds which have no maturity date.

• These bonds have a call option that allows the banks to buy these bonds back from investors at any time.

• At1 bonds are used by banks to strengthen their core or tier 1 capital. They are inferior among all other forms of debt except common equity.

 

Action by SEBI

• SEBI has told mutual funds to consider AT1 bonds as 100 year bonds. This means that these bonds will be redeemed after 100 years.

• SEBI has also asked Mutual Funds to issue AT 1 bonds only at a maximum 10 percent of assets of a scheme.

 

Reason

SEBI made the decision after the Reserve Bank of India (RBI) allowed a write-off of Rs 8,400 crore on AT1 bonds issued by Yes Bank Ltd.

 

Impact on Mutual Funds

• Treating AT1 bonds as 100 year bond raises the risk in these bonds as they become ultra long-term. 

• This can create volatility in prices of the bonds as higher risk status will cause yield of the bonds to increase.

• As the prices of bonds increase, the net asset value of MF schemes holding these bonds will decrease significantly.

 

Impact on banks

• If there are restrictions on investments by mutual funds in AT1 bonds, banks will find it tough to raise capital.

• Banks will suffer if they find it tough to raise capital at a time when they need new funds due to soaring bad assets

 

Reason for Finance ministry direction

• The ministry has sought withdrawal of new directions as it might lead to mutual funds making losses and exiting from these bonds.

• The government is in need of new capital that has to be raised from such bonds as the process of privatising PSU banks is taking place.