The RBI directive will benefit ICICI Ltd which has made a strong pitch for treating Rs 350 crore worth of 20-year preference shares issued by ITC Classic as part of its Tier-I capital. The long-term preference shares carry a non-cumulative nominal dividend of 0.001 per cent.

The RBI directive said the capital adequacy standards followed by the central bank is in accordance with the Bank of International Settlements (BIS) norms which permits inclusion of non-cumulative perpetual preference shares in Tier-I capial. However, since the Companies Act, 1956 does not allow issue of perpetualpreference shares in India, the RBI has decided to allow institutions to treat non-cumulative preference shares with a maximum tenure of 20 years on a par with perpetual preference shares, but with riders.

The RBI has directed the concerned institutions to create a corpus to be invested in government of India securities having maturity conciding with the maturity of such preference shares to eliminate the reinvestment risk. "The corpus should be of such an amount, the investment of which on maturity becomes equal to or more than the amount of such preference shares," it said.

In effect, ICICI would be required to invest in dated government papers maturing in 2018 (the redemption year of the ITC Classic preference shares) if it wants to treat the shares as Tier-I capital.

According to the RBI directive, the difference between the amount of preference shares and the corpus created for investment in gilts will be treated as Tier-I capital. For example, considering the latest yield of 12.45 per cent on a20-year dated paper and a tax rate of 35 per cent, the discounted value of Rs 100 works out Rs 21.09. In this case, the balance Rs 78.91 (Rs 100-Rs 21.09) will be available to the institution to be used in the Tier-I capital.

Going by this example, ICICI will be able to use Rs 196.27 crore worth of the preference shares (out of the total corpus of Rs 350 crore) as part of its Tier-I capital. ICICI had shown a tier-I capital adequacy ratio of 9.5 per cent for the year ended March 31, 1998, which included the entire Rs 350 crore worth of 20-year preference share issue.

The RBI has also directed term-lending institutions to value the investment in gilts every year and replenish the shortfall--if any--by drawing down an equivalent amount from the reserves. "The amount of the corpus should not be available to FIs for their normal operations and hence must be kept separately," it said.

The RBI also made it clear that the amount and the purpose of creating such a corpus should be disclosed in the balancesheet and prospectus prepared for raising resources.

Insight

Sensible idea
The RBI has explained that if the present discounted value of the amount to be repaid to preference shareholders is invested in government securities, then the difference between the amount collected as preference capital and the investment in securities can be considered as Tier-1 capital. The investment of a relatively small amount now would grow to a large amount by the time the preference shares have to be repaid. But since the investment is all that is required to take care of repayment, the rest of the preference capital need not be earmarked for repayment, and can consequently be treated no differently than ordinary share capital, for the purposes of capital adequacy.