Yes Bank AT-1 verdict: Does this instrument fulfil the purpose it was originally designed for?

The judgement does not make AT-1 bonds risk-free. Nor does it invalidate their legitimate loss-absorption role. It does, however, underline a basic principle: financial stability cannot substitute for legal authority, and a crisis does not place regulatory decisions beyond judicial scrutiny.

When the rules fail a rescue: AT-1 bonds were conceived as a source of bank capital that could absorb losses without immediately burdening taxpayers. They are perpetual instruments with discretionary coupons and contractual loss-absorption provisions, occupying an uneasy space between debt and equity.

The Yes Bank dispute raised the question of whether the write-off was authorized under the reconstruction scheme. That determination matters. Investors must accept the risks embedded in their instruments, but regulators must act within the legal framework governing resolution. A rescue may be necessary and successful without every measure adopted during it being legally sustainable.

The court’s ruling should, therefore, prompt a review of the resolution framework, rather than a blanket rejection of AT-1 bonds or an assumption that investors are always entitled to recover their money.

The AT-1 dilemma—a capital instrument in search of a purpose: Its fundamental problem is economic. This instrument is callable at the issuer’s discretion, but not redeemable at the investor’s demand.

Yet, in practice, issuers commonly call AT-1 bonds on their first call date, even when retaining the capital might make better economic or liquidity sense. This market convention weakens their credibility as genuinely perpetual, loss-absorbing capital.

A regulatory capital instrument whose effective life is determined by market convention rather than its contractual design raises legitimate questions about the quality of the capital it provides.

There is a deeper contradiction. In business-as- usual conditions, AT-1 ranks ahead of equity in the payment hierarchy. When solvency comes under pressure, however, its holders can face losses before shareholders have necessarily borne equivalent pain. The Yes Bank controversy, alongside the Credit Suisse episode, exposes this tension between the instrument’s debt-like appeal in normal times and equity-like vulnerability in distress. The precise contractual and legal circumstances differ, but both episodes challenge the assumption that this hybrid can reconcile competing interests without friction.

The investor dilemma is equally stark. AT-1 offers limited upside, making it unattractive to equity investors seeking participation in growth. Its potentially severe downside makes it unsuitable for investors seeking the relative predictability of conventional corporate bonds. Raising coupons to compensate for risk increases banks’ funding costs and can dilute earnings per share.

The original attraction was obvious: equity-like loss absorption without equity dilution. Perhaps it was too good to be true.

India should examine whether AT-1 merits continued recognition as regulatory capital. The Australian Prudential Regulation Authority (APRA) has decided to phase out AT-1 eligibility, with a transition extending to 2032. India need not copy the decision mechanically. But it should consider a phased transition towards simpler, more dependable capital, while protecting existing contractual rights and assessing the implications for banks’ funding costs and lending.

The regulator’s lessons: RBI’s role deserves measured scrutiny. The court’s observations invite questions about whether supervisory intervention could have been more effective and whether the reconstruction scheme adequately specified the treatment of AT-1 holders. The preservation of depositors’ interests and the continuity of Yes Bank were important achievements, but we can still learn from the episode.

There is also the issue of misselling. AT-1 instruments were reportedly sold to some customers as substitutes for fixed deposits, despite their fundamentally different risks. Better disclosure, suitability standards and enforcement are essential. Protecting investors does not mean shielding them from disclosed risks; it means ensuring that the risks sold are the risks understood.

Will the confidence of foreign investors be hurt? The timing is significant. Sumitomo Mitsui Banking Corporation (SMBC) acquired a substantial stake in Yes Bank in 2025, while the litigation remained unresolved. It would be reasonable to assume that the pending case formed part of SMBC’s investment-risk assessment, though its actual assessment of the verdict is unknown.

One Supreme Court judgement need not deter foreign investment. The judiciary correcting a regulatory misstep can strengthen institutional credibility. What investors need, however, is predictability; transparent rules, consistent enforcement and resolution powers that withstand legal scrutiny.

Daiichi Sankyo’s troubled acquisition of Ranbaxy offers a different but relevant reminder of how governance failures can affect confidence in Indian investments. The circumstances are distinct, but institutional credibility remains central to both domestic and foreign capital.

The Yes Bank verdict should prompt neither triumphalism among bondholders nor defensiveness among regulators. It should trigger a serious reconsideration of AT-1’s economic rationale, the quality of bank supervision and the legal foundations of resolution.

Financial stability is indispensable. But a rescue that preserves a bank at the cost of confidence in the rules risks solving one problem by creating another.

The author is a former central banker.