The Centre, in a first move of its kind, has issued Rs 5,500 crore in zero-coupon bonds for recapitalising Punjab & Sind Bank (P&SB).
It has allowed it to park the paper in its held-to-maturity (HTM) category at face value rather than the discounted market rate.
What are zero coupon bonds?
A coupon is a periodic interest received by a bondholder from the time of issuance of the bond till maturity.
Zero coupon bonds, also known as discount bonds, do not pay any interest to the bondholders.
Instead, they get a large discount on the face value of the bond.
On maturity, the bondholder receives the face value of the investment.
In simple words, the investor purchasing a zero coupon bond profits from the difference between the buying price and the face value, contrary to the usual interest income.
What kind of bonds is issued now?
The bonds issued to P&SB are a variation of the recapitalisation bonds issued earlier to public sector banks.
The previous tranches of recapitalisation bonds carried interest and were sold to different banks.
Unlike these, the present bonds are “non-interest bearing, non-transferable special GOI securities”, limited only to a specific bank, and for a specified period (maturity of 10-15 years).
Only those banks, whosoever is specified, can invest in them, nobody else.
It is held at the held-to-maturity (HTM) category of the bank as per the RBI guidelines.
Since it is held to maturity, it is accounted at the face value and no mark-to-market will be there.
Also, though zero coupon, these bonds are different from traditional zero coupon bonds.
One factor is because they are being issued at par, there is no interest.
In previous cases, since they were issued at discount, they technically were interest bearing.
Normally zero coupon bonds are issued at a discount, which are tradable also.
But since these special bonds are not tradable these can be issued at par.
Why is it welcome?
These are special types of zero coupon bonds issued by the government after proper due diligence and issued at par.
The move does not affect the fiscal deficit while at the same time provides the much needed equity capital to the banks.
What is the need for caution?
The government is issuing a zero coupon bond aggregating to Rs 5,500 crore at par to Punjab & Sind Bank that will mature in tranches between 2030 to 2035.
The market value of the bonds would be around Rs 2,750 crore.
The government will infuse Rs 5,500 crore into equity capital of Punjab & Sind Bank.
By doing so, the capital adequacy of Punjab & Sind Bank goes up by Rs 5,500 crore (instead of Rs 2,750 crore).
It is a great innovation by the government where it is using Rs 100 to create an impact of Rs 200 in the economy.
This is indeed a financial illusion.
So essentially, it gives more time to solve the problem, and does not solve the problem permanently.
These bonds may thus not be a permanent solution for the banking sector’s problems.
