AT-1 bonds are not ordinary bank bonds. They pay interest like bonds, but they are designed to absorb losses when a bank gets into serious financial trouble. That is why they can offer higher returns than safer investments, but also carry the risk of investors losing their entire investment.
The Yes Bank case has brought these instruments back into focus. The Supreme Court has set aside the ₹8,415 crore AT-1 bond write-off carried out during the bank’s reconstruction in March 2020. The bank must now assess the implications for its earnings, capital and coupon payments.
What are AT-1 bonds?
AT-1 stands for Additional Tier 1. These are special bonds issued by banks to raise capital and meet regulatory requirements.
Think of a bank’s capital as a financial cushion. If the bank makes losses, this cushion helps absorb them and protects depositors and the wider banking system.
AT-1 bonds form part of a bank’s Tier 1 regulatory capital, alongside its core equity capital.
Although investors buy these bonds and receive interest, AT-1 instruments carry risks that ordinary bonds do not. Under specified conditions, their principal can be written down or converted into shares.
Why do banks issue AT-1 bonds?
Banks need capital to support lending and absorb potential losses. They can raise capital by issuing shares or qualifying AT-1 bonds.
AT-1 bonds allow banks to raise funds without immediately issuing new equity shares. In return, investors receive a specified coupon, or interest payment, subject to the terms of the instrument.
For investors, the attraction is typically a higher interest rate. For banks, the advantage is that these instruments count towards regulatory capital requirements.
The trade-off is that investors take on significantly higher risks than they would with conventional bank bonds or fixed deposits.
What does ‘perpetual’ mean?
A normal bond has a maturity date. For example, a five-year bond issued in 2026 would generally be due for repayment in 2031, subject to its terms and the issuer’s ability to pay.
AT-1 bonds are perpetual instruments, which means they have no fixed maturity date.
This means:
- The bank is not automatically required to repay the principal after five, ten or any other fixed number of years.
- Investors may continue receiving annual interest for as long as the bonds remain outstanding and the coupons are payable.
- Investors cannot demand repayment simply because they have held the bonds for a certain period.
In other words, an investor could hold an AT-1 bond for decades without a guaranteed date for getting the principal back.
What is a call option? Does the bank have to repay the bonds after five years?
A call option is the bank’s right to redeem or repay the bonds before they would otherwise be repaid. It is not the investor’s right.
For qualifying AT-1 instruments, the first call is generally permitted only after at least five years. The bank must obtain prior RBI approval and satisfy the applicable regulatory conditions, including requirements relating to its capital position or replacement capital.
For example, suppose a bank issues an AT-1 bond worth ₹100 crore carrying a 10% annual coupon. After five years, the bank may have the option to repay the ₹100 crore, subject to the bond terms, RBI approval and regulatory conditions.
If the bank exercises the call, the bonds are redeemed and the principal is repaid in accordance with the terms. If the bank does not exercise the call, the bonds remain outstanding. There is no automatic repayment of the ₹100 crore.
Why might a bank choose not to exercise the call? It may want to preserve its capital, or replacing the bonds with fresh capital may be expensive. The five-year mark is an opportunity for the bank to call the bonds, not a maturity date. The bank is not automatically required to repay the principal at that point.
Does the bank have to pay interest every year?
Not necessarily. This is another major difference between AT-1 bonds and conventional bonds. The interest payment is called a coupon. An AT-1 bond may carry a stated annual coupon rate, such as 9% or 9.5%. However, that rate does not, by itself, guarantee that the bank must pay interest in every circumstance.
Under the applicable AT-1 rules and the instrument’s terms, the bank must have the discretion to cancel coupon payments. These payments are generally non-cumulative, meaning that a coupon validly cancelled does not automatically become payable in a later year.
Consider a ₹100 crore AT-1 bond carrying a 9% annual coupon. If the coupon is payable under the applicable terms, the annual payment would be ₹9 crore. If the bank validly cancels the coupon under the instrument’s provisions, the investor may not receive that year’s ₹9 crore.
The missed coupon does not automatically accumulate as a debt payable in a future year.
However, the Yes Bank case has a specific legal dimension. Paragraph 81 of the Supreme Court judgment states that annual coupon payments must remain unaffected by the outcome of the appeals and must be made in accordance with the bonds’ Information Memoranda.
The bank is examining the implications of this direction and whether it has any discretion over coupon payments. The specific judgment and contractual terms are critical to determining the bank’s obligations.
Can investors lose their entire principal?
Yes. This is one of the defining risks of AT-1 bonds.
These instruments are designed to absorb losses if a bank reaches specified financial distress triggers, including the point at which it is considered non-viable.
Depending on the terms and applicable rules, the bonds may be:
- Written down: The principal is reduced, potentially to zero.
- Converted into equity: Investors receive shares instead of retaining their original bond claim.
A write-down can be permanent. If the principal is written down to zero, investors could lose their entire investment.
This is not the same as a bank simply delaying repayment on a normal bond. Loss absorption is built into the design of AT-1 instruments.
In Yes Bank’s case, the bonds were written down to zero in March 2020 during the bank’s reconstruction. Bondholders challenged the decision, and the Supreme Court has now upheld the Bombay High Court’s decision setting aside the write-off.
The dispute concerns whether the write-off was legally authorised under the reconstruction scheme, not whether AT-1 bonds can ever carry loss-absorption provisions.
Where do AT-1 bondholders rank if a bank fails?
AT-1 bondholders are not in the same position as depositors. Broadly, AT-1 bonds are unsecured and subordinated. This means their claims rank below those of depositors and ordinary creditors, while ranking ahead of equity shareholders under the applicable contractual hierarchy.
In a simplified ranking:
- Depositors and higher-ranking creditors generally rank ahead of AT-1 bondholders.
- AT-1 bondholders have subordinated claims and may face a write-down under the applicable provisions.
- Equity shareholders generally rank below AT-1 bondholders in the creditor hierarchy.
This is a simplified illustration, not a guarantee of recovery. The actual outcome depends on the applicable resolution or insolvency framework, the terms of the instruments and the circumstances of the bank. AT-1 loss-absorption provisions can also operate before a conventional liquidation.
What exactly happened in the Yes Bank case?
March 2020: Yes Bank’s AT-1 bonds worth Rs 8,415 crore were written down to zero during the bank’s reconstruction.
January 2023: The Bombay High Court set aside the write-off, holding that the Administrator lacked the authority to carry it out under the final reconstruction scheme.
October 15, 2026: The Supreme Court upheld the Bombay High Court’s decision. It also clarified that annual coupon payments must remain unaffected by the outcome of the appeals and be made in accordance with the Information Memoranda.
Now: Yes Bank is assessing the implications for reinstatement, coupon payments and the accounting adjustment.