Brain Booster for UPSC & State PCS Examination (Topic: Zero Coupon Bonds)

Brain Booster for UPSC & State PCS Examination

Current Affairs Brain Booster for UPSC & State PCS Examination

Topic: Zero Coupon Bonds

Zero Coupon Bonds

Why in News?

  • The government has used financial innovation to recapitalise Punjab & Sind Bank by issuing the lender Rs 5,500-crore worth of non-interest bearing bonds valued at par.
  • The funds raised through issuance of these instruments, which are a variation of the recapitalisation bonds issued earlier to public sector banks, are being deployed to capitalise the state-run bank.

Zero-Coupon Bond

  • A zero-coupon bond is a debt security that does not pay interest but instead trades at a deep discount, rendering a profit at maturity, when the bond is redeemed for its full face value.
  • A zero-coupon bond is also known as an accrual bond.
  • The difference between the purchase price of a zero-coupon bond and the par value, indicates the investor's return.
  • This support will now facilitate the bank to use this capital to expand its banking activities for agriculture, rural and MSME sectors, with its prominent presence in Punjab, Haryana and Delhi, which account for nearly 900 out of its 1,500 branches.
  • The significant aspect is that the capital support will be achieved without the government really infusing funds (no cash outgo) in the bank.

What kind of bonds are these?

  • These are “non-interest bearing, non-transferable special GOI securities”.
  • It is not tradable bond.
  • It has a maturity of 10-15 years and issued specifically for Punjab & Sind Bank.
  • 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, not requiring it to book any mark-to-market gains or losses from these bonds.

Difference from zero coupon bonds issued by Private Firms

  • Though zero coupon, these bonds are different from traditional zero coupon bonds on one account — as 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. Here, there is no question of trading and these are special types of bonds, which the government issues specifically to a specified person and it’s issued at par.
  • Since they are issued by the government, thus they are only to be purchased by the buyers (banks) selected by the issuing authorities. It is not open to public. Normally, private issued bonds are open for institutional buyers and sometimes to retail investors too.

Significance of Zero-Coupon Bond

  • Though these will earn no interest for the subscriber, market participants term it both a ‘financial illusion’ and ‘great innovation’ by the government where it is using Rs 100 to create an impact of Rs 200 in the economy.
  • It 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 this bonds would be around Rs 2,750 crore.
  • Punjab & Sind Bank, by investing in these bonds from held-to-maturity category, won’t have to book mark-to-market loss and will value the bonds at cost, i.e. Rs 5,500 crore.
  • 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 an innovative way to capitalise banks, which does not affect the fiscal deficit while at the same time provides much needed equity capital to the banks.