The Reserve Bank of India (RBI) is examining whether banks’ recent purchases of low coupon corporate bonds have potentially breached regulations and has asked banks to provide more information, three people with direct knowledge of the matter said. The inquiries from RBI, though preliminary, are raising fears of stricter guidelines, these sources said, citing emails or calls from central bank officials, after sales of these low coupon bonds surged in the current financial year.
Specifically, RBI is examining whether banks are fully following guidelines released in September 2010 mandating that banks only buy zero coupon bonds if the issuer has set up a “sinking fund” for all accrued interest during the maturity of the debt. The sources said RBI was examining whether issuers avoided establishing the sinking fund by setting up low coupon bonds that offered low interest and thus avoided meeting the technical definition of a zero coupon bond, even if they shared some of the same risks.
RBI circular refers to zero coupon and not low-coupon bonds. “There was an email sent asking for data on all low coupon bonds,” one source who had received the letter told Reuters, adding the email referred specifically to the 2010 circular.
A central bank official declined to comment on the issue.
RBI passed the 2010 guidelines because of concerns banks would have little information on the issuer’s cash flow and hence would not be able to gauge the potential impact should the company default at redemption.
Zero coupon bonds offer no interest during the tenure of the bond, but promise a premium at redemption. In India, banks arrange bond deals by buying the debt from the issuer and then try to sell them on to mutual funds and insurance companies.
Zero- and low-coupon bonds are usually popular with issuers undertaking a project with limited cash flows in the initial period, or who want to replace high interest bearing loans. Corporates have issued $735 million with coupon rates of 5 percent or below since the financial year started in April, compared with $58.6 million in the 2011/12 period, according to Thomson Reuters data, marking a more than 12-fold increase.
By contrast, zero coupon bond sales have dropped to $752 million in the financial year ending in March 2013, compared with $2.76 billion in the previous financial year. One of the sources with direct knowledge of the deal told Reuters the RBI has also asked for more information from banks if they have resold the bonds to other investors.