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Recently in India, one of its largest banks issued something called Basel-3 compliant bond. Details here - https://www.business-standard.com/article/finance/state-bank-of-india-raises-rs-5-000-cr-by-issuing-basel-iii-compliant-bonds-120102601322_1.html

I am trying to understand, what is exactly basel compliant bond? When a bank issue this bond, then effectively it borrows money which is actually a liability not an asset which it needs to pay back later, right?

So, how can a bank then bump up it's capital by issuing a bond whatever form from a basel compliance perspective?

As an individual, I can not certainly show all my borrowings as my financial good health, isn't it?

Or, I am missing something important on basel compatibility?

Appreciate for any insight.

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The journalist that wrote this article doesn't understand what he's writing about. When such articles appear on Bloomberg or Reuters, they are usually computer-generated, so programming bugs can be blamed for something stupid being written. But here a clueless and ignorant human being is probably responsible for the quote.

There are no "Basel-compliant" or "Basel III compliant" bonds. This just makes no sense.

These SBI bonds qualify (supposedly) as Tier 2 capital. A good discussion of what this means is found in this FDIC paper, pages 2.1-3 and 4 and in Basel III definitions of regulatory capital (10-16 et al).

Briefly: Tier 2 bonds are issued usually by banks. Typically, they are subordinated debt - below tier 1 debt. Banks often classify their tier 2 into upper and lower.

Upper tier 2 bonds typically have coupons that are "deferrable" and "cumulative", which makes these bonds senior to tier 1 (deposits, dividends on preferred equity, etc..).

Lower tier 2 bonds are subordinate to depositors' and common and preferred shareholders' claims. Realistically, they will have 0 recovery if the institution goes under. Compared to the same bank's senior bonds, they typically have a notch lower agency ratings and yield as much as 1-2% more.

Basel III and various local regulators require specific criteria for bonds to qualify as Tier 2 capital, and also limit how much of it an institution can sell.

Note that Basel III completely abolished Tier 3 capital, which some banks (especially badly run and corrupt banks in emerging markets) used to use for issuing junk bonds. So perhaps the article meant "we used to issue Tier 3 junk; now that we're no longer allowed by foreign regulators, we issue Tier 2 junk".

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  • $\begingroup$ Thanks for all these insight. But I still don't understand that, how an issued bond (i.e. borrowed money) can be regulatory capital? $\endgroup$ – Daniel Oct 27 at 17:21
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    $\begingroup$ OK, imagine that you're a bank. You'd like to loan \$1 to someone, who will repay you with interest. But for that, you must have the \$1 to loan out. There are a few ways you can raise the \$1, such as: convince someone to deposit \$1, e.g. in a 'certificate of deposit' - later you give them \$1 plus interest; you sell equity (common or preferred) and pay dividends to shareholders; you issue a bond, and later repay it with interest; et al. You hope that the costs that you pay for your capital (interest, dividends) will be less than what you charge when loaning your capital to risky borrowers. $\endgroup$ – Dimitri Vulis Oct 27 at 17:33

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