Yes Bank AT1 Bond Saga — RBI Needs To Tighten Drafting Of Norms

A nuanced reading shows that the judgment is based largely on the Bombay HC judge’s assessment of narrow technical issues.
<div class="paragraphs"><p>(Source: Yes Bank/FB page)</p></div>
(Source: Yes Bank/FB page)

Even as the headlines on Friday screamed that Yes Bank Ltd. has lost the case against additional tier-1 bondholders, a nuanced reading would have shown that the judgment is based largely on the Bombay High Court judge’s assessment of narrow technical issues, such as timing and powers of the administrator of the bank.

"It appears that administrator exceeded his powers and authority in writing off AT-1 bonds after the bank was reconstructed on March 13, 2020," according to the court order.

So, the court has not based its judgment on whether the bank can write-off additional tier-1 bonds, or whether such hybrid bonds can be wiped out, even as equity holders are not impacted, or whether the bondholders were victims of misselling.

According to anecdotal evidence, there is a genuine case for some retail bondholders to be aggrieved that the bank’s personnel mis-sold such hybrid bonds as being similar to fixed deposits, and never explained the actual risk in such an investment. These retail bondholders may have a case to approach the courts or relevant authorities to try and recover their money from the bank, unlike institutional bondholders who definitely knew what their money was being invested in and the risks such bonds carried.  

But, let us not conflate the issue of misselling with the judgment as a large part of commentary seems to be doing. In the misselling case, there is already a Securities and Exchange Board of India order that fined the bank, its personal wealth management team and its founder Rana Kapoor for misselling such bonds to individual investors. 

The order portion cited above and related sections show that the judge ruled on the technical point that Yes Bank had been reconstituted as per an order on March 13, 2020, and so the administrator’s decision to write off these bonds on March 14, 2020 “needs to be set aside”. 

An important point to note is that the administrator of the bank, Prashant Kumar, who was appointed by the Reserve Bank of India subsequently became the managing director and chief executive officer of the reconstituted bank, but the court has ruled purely on his decision which was taken in the capacity of administrator of the bank. 

What Are AT1 Bonds And Why They Could Land Yes Bank In Trouble? BQ Explains

What Has Happened So Far

To quickly recap, Yes Bank was in a very precarious position and severely under-capitalised, and at the risk of defaulting on regulatory requirements in March 2020, due to the sharp increase in bad loans that eroded profits and capital.

The RBI imposed a moratorium on Yes Bank on March 5, 2020, due to its weak financials and to protect depositors' interests. Prashant Kumar, who was a deputy managing director and chief financial officer of State Bank of India, was appointed as the administrator of Yes Bank effective March 6, 2020. 

On March 6, 2020, the RBI released a draft scheme of reconstruction for Yes Bank, which specifically mentioned permanently writing down additional tier-1 bonds issued by the bank. This was possible since additional tier-1 bonds are hybrid bonds, which carry quasi-equity characteristics, and so are riskier and attract a higher rate of interest.

According to the norms for such bonds, when there is a trigger event such as weak capital position, a bank can stop paying interest on such bonds or convert them into equity or even write them off altogether.

While traditionally such bonds are deemed senior to common equity, there is no such specific mention of seniority in a bond document, which meant that RBI’s draft scheme was legally prescient in suggesting such a write-off, even as it only altered the value and imposed a bar on sale of shares by equity holders.  

However, the final order issued by the government on the reconstruction of Yes Bank on March 13, 2020, did not include this clause on write-off of tier-1 bonds worth almost Rs 85 billion (Rs 8,500 crore). But, it did not specifically stop the bank from taking any such action. Thus, on March 13, 2020, when the bank was reconstructed, these bonds were effectively part of the books of the reconstituted bank.

This is precisely why the administrator Kumar, likely based on the draft scheme that RBI had issued earlier, went ahead and announced that these tier-1 bonds were being fully written off. 

And this discrepancy between the draft scheme from the RBI and the final scheme that the government announced has come back to haunt Yes Bank, almost three years after it was placed under moratorium. To put it simply, it is this timing of reconstitution of the bank on March 13, 2020, and the legality of the write-off decision announced by the administrator a day later that has proved to be the basis for the ruling by the court on Friday. 

Yes Bank CEO Says Paying Interest On AT1 Bonds Is At Lender's Discretion

Key Questions

The real question that needs to be asked to the RBI and the government is why did the final scheme differ from the draft scheme on the issue of additional tier-1 bonds? Was this by design to not step into a decision that should be taken by the reconstructed bank and thus avoid becoming party to such lawsuits?

The other key question is why did the schemes not write off the equity of the bank as happened in the case of Lakshmi Vilas Bank, where equity and tier-2 bonds were written off? 

If the equity had been written off, then the bond holders could not have made a case of being treated unfairly vis-a-vis equity investors. To be clear, this argument is based only on traditional understanding that tier-1 bonds are senior to equity, and not specified in any contract. 

To take a broader look on the issue, the RBI has traditionally been the final voice on many issues in the financial sector, and there have been few material challenges to its powers to make norms till recent years. 

But, this has been changing, and with certain court rulings going against the RBI, there should be a concerted effort within the central bank to ensure that not only the spirit but also the letter of its communication is legally sound.  

Just a few years ago, the RBI’s strong Feb. 12, 2018, circular on stressed assets was struck down on purely technical grounds, but an almost similar circular with tighter wording was issued on June 7, 2019 and is the basis for stressed asset resolution today. The spirit of Feb. 12, 2018 circular was thus kept alive but with greater focus on specificity of wording in June 7, 2019 notification. 

Similarly, while the case against RBI on promoter stake reduction was withdrawn by Kotak Mahindra Bank founder and promoter Uday Kotak, the wording of the RBI norms on equity issued by banks was subsequently updated.

RBI and Uday Kotak settled the issue outside court before it reached the ruling stage, so we will never know how the court would have ruled, but the central bank reworking its norm to be more specific is an indication on why they decided to settle out of court.

Even in the case of the RBI’s circular on banks providing services to cryptocurrency platforms, the court ruled against the central bank citing lack of proportionality. The central bank has since stuck to its remit and used its voice to warn citizens against investing in such assets, while simultaneously calling on the government to come up with a legal framework to deal with this issue holistically.  

Beyond The Letter Of The Law

As seen in the latest case of Yes Bank, there is a need for the RBI, and by extension the government, to be more specific when wording their notifications and laws, so that there is no retrospective legislative action against steps taken pursuant to issuance of such norms. 

This is not to say that the courts are always right when they choose to interpret a law purely based on the way they are worded.  

Take the case of the courts not allowing defaulting loans to be declared as non-performing in 2020 post the Covid-19 pandemic, even when the repayments had stopped from the borrowers. This left banks in limbo on announcing the real picture on asset quality on their books, till the courts finally lifted the stay almost six months later.

This was a clear case where the courts should have deferred to the RBI’s powers as banking regulator to come up with norms, and not allowed defaulters to avoid being recognised as defaulters.

The courts, including the Supreme Court, should also be aware of past judgments by them which have set back sectors in the economy by decades. We don’t have to go too far back in history to find rulings that are sound in law but fall short on being realistic, when we study rulings such as coal block allocation cancellations or the Adjusted Gross Revenue ruling in the telecom sectors. 

The RBI and the government’s action in reconstructing Yes Bank in 2020 was aimed at preventing the failure of a large bank that would have eroded depositor interest, and hurt all sections of investors and the broader banking system.

The central bank and the government’s actions saved Yes Bank, protected depositors and enabled it to revive by bringing in new credible investors. That would not be possible if Yes Bank had carried the Rs 85 billion (Rs 8,500 crore) liability from tier-1 bonds on its books. This is a fact that must not be forgotten when we look back at the reconstruction of Yes Bank in hindsight. 

Even as there is a strong argument to be made for better wording of norms by regulators, such as RBI and even SEBI, so that they stand up to legal scrutiny, there is also a case for the courts to go beyond the letter of the law and study the true intent. 

T Bijoy Idicheriah is a senior financial journalist who has been writing on the world of banking and central banking for 17 years.

The views expressed here are those of the author, and do not necessarily represent the views of BQ Prime or its editorial team.


T. Bijoy Idicheriah, is a senior financial journalist w...more
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