ICICI Bank and the issue of Long

Term Bonds

A Case Study

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 Headline Facts of the Case
• In pursuance of Govt of India decision to persuade
banks to fund long term infrastructure projects, RBI,
vide their circular dated 15th July 2014, motivated
banks to raise long term resources, by way long term
Bonds’ issues, to finance Long Term Infrastructure
projects and the affordable Housing sector.
• The minimum maturity period of these bonds was to
be 7 years, and there was no limit on the quantum of
such bonds to be issued by banks.
• The Bonds were to be placed without “Call or Put”
options and may be issued with Fixed or Floating
Interest Rates.

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 RBI encouraged banks to raise long
term Bonds to fund infrastructure
• Towards this end, RBI offered certain incentives to banks, in
respect of the proposed bonds issue, e.g
• 1.*Exemption from Computation of NDTL (Net Demand &
Time Liabilities)
• These Bonds will be exempted from the computation of
NDTL and would therefore not be subjected to CRR & SLR
requirements.
• However, this exemption will be subjected to a ceiling
equal to the eligible credit created out of these funds,
and which will hence be equal to the Bonds’ funds that
are used to incrementally finance long term infrastructure
projects and affordable Housing loans.

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 RBI encouraged banks (contd)
• 2 *Relaxation in Priority Sector lending Norms
• Eligible Bonds will get exemption in computation of
ANBC ( Adjusted Net Bank Credit) for the purpose of
Priority Sector Lending Benchmarks. This means that
the infra loans and affordable housing loans created
out of these bond funds will be exempt from ANBC
calculation.
• ANBC = Bank Credit in India – (Bills Rediscounted with
RBI) – (loans against FCNR B deposits)– (Eligible
amounts of investments in Long Term Infrastructure
Bonds) + (Non SLR investments in HTM category )+
(RIDF deposits with NABARD)

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 Why should ICICI Bank float the
Bond’s Issue
• To participate in the economic development of the nation. Banks
are shouldering 24% of infrastructure financing while Govt. is
shouldering 45% of infrastructure funding. Planning Commission
had envisaged huge investments of the order of Rs. 65 Trillion to
attain the targeted GDP growth of 8% per year.
• Infrastructure lending in ICICI Bank had grown at a CAGR of 27.8%
in the past 3 years and had reached a level of 15% of total loans of
the Bank in March 2014. This pace can be maintained with
increased profitability.
• The share of long term deposits (of tenure over 3 years) in the
total deposits of ICICI Bank had come down from 33% (in the year
2000) to 20% (in the year 2013). This mismatch had created a
Liquidity Risk which needed to be corrected and the proposed Long
Term Bonds issue can correct it by creating a new line of long term
source of funds.

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 Management of Liquidity Risk
• The Basel 3 Framework on Liquidity Risk, defines a Liquidity Coverage Ratio (LCR)
as the ratio of High Quality Liquid Assets (HQLAs) to Total estimated Net Cash
outflows over the next 30 days ( LCR should be 100%).

• As per RBI direction, the Numerator of LCR ie HQLAs does not include CRR assets
and includes only 2% of the SLR assets. Thus to maintain LCR at the desired 100%
level, banks will have to create new HQLAs; and Investments in Govt Securities is
one such avenue. The additional resources created by the proposed Bonds issue
can be invested in Govt Securities meant for infrastructure development.

• The denominator of the LCR includes a fraction of all Callable liabilities within
the next 30 days, plus 40% of wholesale term deposits and 5-10% of the retail
Term deposits. Since ICICI Bank had a high CASA ratio so it had a fat denominator
of the LCR.
• However, the proposed Bonds issue did not have a Put option (Non retractable
by the holder), and hence they will not be included in the calculation of Net Cash
Outflows and will therefore not impact the LCR negatively by adding to the
denominator.

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Management of Interest Rate Risk
The proposed New Bonds will add to Interest Rate Risk
because these will be Fixed Rate Bonds (in accordance
with the investor appetite at that time) but will be
utilized to fund Floating Rate Assets (infrastructure
Loans).
The facts of the case suggest that as a measure to balance
the Interest Rate Risk arising from the issue of Fixed
Rate Bonds, ICICI Bank would explore the possibility of
offering Fixed Rate loans to infrastructure projects.
Additionally they will increase the Duration of existing
assets (Govt. securities) to balance the increase in
Duration of liabilities (Proposed Long Term Bonds)

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 Risks in issuing Long Term Bonds
• These will be Fixed Rate Long Term Bonds as the
Investor appetite at that time was for Fixed
Rate Bonds due to a falling interest rate scenario
perception.
• The interest cost for Fixed Rate Long Term Bonds
being considerably higher than CASA deposits
and Term Deposits, it will increase the Average
Cost of Funds of the Bank.
• However, the RBI incentives will somewhat
reduce the cost of funds, the extents of which
benefit can not be quantified.

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 What actually happened?
• A news item in Mint newspaper of Wednesday
3rd September 2014
• “ Late on Tuesday 2nd September 2014, ICICI Bank
issued 10 Year Infrastructure Bonds worth Rs.
3,900 crore at a semi annualized coupon interest
rate of 9.25%; and Insurance firms, Pension
Funds and Mutual Funds rushed to buy it. This is
likely to open the floodgates for banks trying to
raise money to finance high cost long gestation
infrastructure projects such as Roads, Ports and
Power plants.

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 What actually happened (contd)
• This is ICICI Bank’s second such issue after RBI’s
approval a few weeks ago. In July, it raised Rs.
700 crore by selling similar bonds to investors.
Andhra Bank and Kotak Mahindra Bank are the
other banks that have raised money through such
bonds.
• IDBI Bank, Axis Bank and Kotak Mahindra Bank
may raise money before the end of the month to
finance infrastructure and affordable housing
projects.

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