Write-off of Lakshmi Vilas Bank's debt to sting small lenders

By Divya Patil

India’s smaller banks will likely face higher funding costs and reduced investor appetite for their bonds just as non-performing loans spread, after the central bank moved to write off debt of an ailing lender.

The Reserve Bank of India on late Thursday said 3.18 billion rupees ($43 million) of Tier 2 bonds of Lakshmi Vilas Bank Ltd. will be fully written down as DBS Group Holdings Ltd. acquires the lender.

The announcement comes as a surprise after the RBI-appointed administrator said last week DBS would take over all obligations, including bonds. It also underscores risks in India’s credit market after some individuals lost money on different kinds of bank bonds earlier this year when authorities seized Yes Bank Ltd.

“Financing costs may inch up and the appetite shall be lower especially for the lower-rated private and small finance banks,” said Ajay Manglunia, managing director and head at JM Financial Products Ltd. “Such lenders will have to rely more on equity raise as investors shall be a bit more skeptical to take risk now.”

Many investors in bank notes tend to buy and hold the securities, rather than actively trade them. That’s limiting the impact on traded levels from the Lakshmi Vilas’ bond write-off. But observers said that the incident could prompt market participants to reassess their investment in Tier 2 notes and demand higher yields in future offerings from lenders.

Average yields on top-rated bank securities due in 10 years, which were little changed Friday, have already edged up 14 basis points from their low for the year touched in August.

Any further weaking in demand for bank bonds would add to pressure on lenders already saddled with one of the world’s worst bad debt piles. Banks also need to boost their capital in anticipation of more soured loans as the fallout of the pandemic batters businesses.