# Basel compliant Bonds

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.

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".

• Thanks for all these insight. But I still don't understand that, how an issued bond (i.e. borrowed money) can be regulatory capital? Oct 27 '20 at 17:21
• 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. Oct 27 '20 at 17:33