Transition from LIBOR
RBI has issued an advisory to Banks to cease entering into new financial contracts that reference LIBOR as a benchmark and instead use any widely accepted alternative reference rate (ARR).
Details
London Interbank Offered Rate (LIBOR) is a benchmark interest rate at which the global banks lend to each other. LIBOR is also linked to interest rates at which Indian corporate sector borrows money under external commercial borrowings. The rate is calculated and published each day by the Intercontinental exchange (ICX).
In the aftermath of LIBOR scandal of 2011, some countries have decided to adopt alternatives to LIBOR by the end of 2021.
Some of the alternatives to LIBOR are:
- UK: Sterling Overnight Index Average (SONIA)
- USA: Secured Overnight Financing Rate (SOFR)
- Switzerland: Swiss Average Rate Overnight (SARON)
- Japan: Tokyo Overnight Average Rate (TONAR)
- European Union: Euro Short-Term Rate (ESTER)
Note: Mumbai Interbank Offered Rate (MIBOR) is India’s domestic reference rate for inter-bank lending. The MIBOR is calculated every day by National Stock Exchange of India (NSEIL).
SWIFT
Society for Worldwide Interbank Financial Telecommunication (SWIFT) is a secure financial message carrier that transports messages from one bank to its intended bank recipient to facilitate cross-border payments. It does not facilitate funds transfer: rather, it sends only payment orders.
Details about SWIFT
- Global member-owned cooperative headquartered in Brussels, Belgium. Founded in 1973.
- Presently, it has more than 11,000 Banks and financial institutions which are spread across 200 countries. Prior to SWIFT, the only reliable means of message confirmation for international funds transfer was Telex. It was discontinued due to a range of issues such as low speed, security concerns etc.
- SWIFT hosts an annual conference known as Sibos (Swift International Banking Operations Seminar) in various cities across the world.
How does the SWIFT work?
SWIFT Code or Bank Identifier Code: Every Bank has a SWIFT Code consisting of 8 or 11 characters. An 11-digit code refers to a specific branch, while an 8-digit code (or one ending in 'XXX') refers to the bank's head office. It is also referred to Bank Identifier Code (BIC). It is like the IFSC code used for domestic interbank transfers, with Swift being used for international transfers.
Alternatives to SWIFT
- Russia developed its own alternative to SWIFT called as System for Transfer of Financial Messages (SPFS). But this system has struggled to establish itself in international transactions.
- Similarly, China has launched the Cross-Border Interbank Payment System in 2015 to internationalise the use of the yuan. It allows global banks to clear cross-border yuan transactions directly onshore.
AT-1 Bonds
BASEL-III Guidelines
According to the RBI’s guidelines, the regulatory capital to be maintained by the Indian banks under BASEL III is as under:
- Tier-1 Capital: 7% (Core Equity capital consisting of Minimum Common Equity Tier 1 of 5.5% and Additional Tier 1 capital of 1.5%)
- Tier-2 Capital: 2% (Comprising of Debt)
- Capital Conservation Buffer: 2.5%
- Total Regulatory Capital: 11.5% of Risk-weighted Assets
Additional TIER-1 Bonds
The AT-1 Bonds are the unsecured and perpetual bonds which are issued by the Banks to meet regulatory capital requirements of 1.5% of Additional Tier 1 Capital under the BASEL III norms. However, they are quite different from the normal bonds in various ways:
Hybrid Instruments: AT-1 Bonds are hybrid of shares and bonds. Just like shares, there is no obligation to return the money or pay the dividend. Just like bonds, the bank pay interest on such AT-1 bonds.
Perpetual Bonds: These Bonds do not have maturity period. Instead, these bonds carry call options i.e., the banks have an option redeem them after five or 10 years. But banks are not obliged to use this call option and they can opt to pay only interest on these bonds for perpetuity. That is why they are called as Perpetual Bonds.
No Put Option: Investors do not have put option i.e., investors cannot return back AT-1 bonds to banks. However, investors can sell these bonds in secondary market.
Skip Interest Payments: Banks issuing the AT-1 bonds can skip payment of interest for a particular year. They can also reduce the face value of the bond. However, the banks can do so only when their regulatory capital ratio falls below certain threshold levels. These threshold levels are clearly specified when Banks issue AT-1 bonds.
Writing down of AT-1 Bonds: If RBI feels that any bank is under a financial crunch, it can waive off liability of banks to redeem the AT-1 bonds and completely write it off. The RBI has used this option in the case of Yes Bank.