Why in news?

• Banks are rapidly issuing Tier II bonds to strengthen their capital base at a time when companies are raising record amounts through IPOs.
• The banking system is expected to raise about ₹25,000 crore this financial year, with ₹10,000 crore already raised.
• The surge is fuelled by three key factors:
  • High demand for long-term debt instruments,
  • Expectations of a repo rate cut in the upcoming monetary policy, which would make current borrowing costs attractive, and
  • Regulatory requirements pushing institutions to invest in such bonds.
• Together, these conditions have created a favourable window for banks to tap the market aggressively.

What’s in Today’s Article?

• What Tier II Bonds Are and Why Banks Use Them?
• Banks Step Up Tier II Bond Issuances Amid Favorable Market Conditions
• Why Banks Are Turning to Tier II Bonds?

What Tier II Bonds Are and Why Banks Use Them?

• Tier II bonds are long-term debt instruments that banks issue to strengthen their capital base.
• With a minimum tenure of five years, they help banks meet Basel III capital adequacy norms and create an additional buffer to support future credit expansion.
• These bonds allow banks to raise low-cost, long-term capital without diluting equity, making them an efficient funding tool.
• Experts note that Tier II instruments also improve a bank’s capital-to-risk weighted assets ratio (CRAR) by adding extra stability to its balance sheet.
  • CRAR is a key financial metric that measures a bank's capital against its risk-weighted assets to assess its financial strength.
  • It is calculated by dividing a bank's capital (Tier 1 and Tier 2) by its risk-weighted assets and is expressed as a percentage.
  • A higher CRAR indicates a bank is more capable of absorbing potential losses, which promotes financial stability and protects depositors. 

Banks Step Up Tier II Bond Issuances Amid Favorable Market Conditions

• India’s top banks are accelerating Tier II bond issuances.
  • SBI recently raised ₹7,500 crore at a competitive 6.93% via 10-year bonds, while ICICI Bank raised ₹1,000 crore in June.
  • Experts estimate that banks may collectively raise up to ₹15,000 crore by December.
• Many lenders waited earlier due to ample liquidity, lower deposit rates, and expectations of future rate cuts, which would reduce borrowing costs. Last year, banks had raised nearly ₹31,000 crore through Tier II bonds.
• This renewed surge reflects improving market appetite and banks’ need to strengthen their capital base.

Why Banks Are Turning to Tier II Bonds?

• Banks are issuing more Tier II bonds because current market conditions make long-term borrowing cheaper than raising funds through deposits.
• With corporate issuers favouring shorter-term bonds this year, there is strong demand for long-duration, high-quality debt, creating a favourable window for banks.
• Market Factors Driving the Surge
  • Expectation of a repo rate cut in December is encouraging investors to lock in long-term yields now.
  • Scarcity of top-rated long-tenor bonds has boosted appetite for Tier II issuances.
  • SBI’s aggressively priced 6.93% bond has acted as a benchmark, increasing confidence among other banks.
  • Provident and pension funds must meet regulatory investment quotas, pushing demand for long-term corporate bonds.
• Regulatory and Strategic Considerations
  • Some banks also need to refinance older bonds whose call options were exercised.
  • With stable markets and attractive yields, banks see this as the right time to strengthen capital buffers rather than wait for uncertain conditions later in the year.
• Tier II Bonds Are Not the Primary Funding Source
  • Experts note that Indian banks still rely mainly on deposits for growth and capital needs.
  • Most large banks have adequate internal capital generation and sufficient buffers, so future Tier II issuances will depend on how attractive market conditions remain.