The Act, which says that the capital of a banking company shall consist of only ordinary shares, does not permit the issue of preference shares or any other category of shares by banking companies, with one exception: only preference shares issued before July 1, 1944 (54 years ago) have legal sanction.

This clause effectively prevents banks from raising Tier 11 capital through one more route in today's scenario. The grouse is that banks which have been raising Tier 11 capital after they augmented their Tier 1 capital by tapping the capital markets have mainly had to do so by private placement of bonds.

The clause is perceived as being particularly restrictive as it cuts them off from hiking up their Tier 11 capital further through the preference share route at a time whenthe Reserve Bank of India (RBI) has tightened capital adequacy requirements for banks in its recent monetary policy review. In fact, an RBI circular lists preference shares as one of the possible avenues through which a bank can raise Tier 11 capital. A senior public sector bank official points out that banks cannot take advantage of the circular and go ahead only because of this clause in the Banking Regulations Act.

Banks, in fact, have been raising Tier 11 capital, which cannot exceed 50 per cent of Tier 1 capital, from time to time. State Bank of India had come out with a concurrent equity and bond issue in 1994, while Bank of Baroda followed up its maiden public issue of equity with a bond issue through the private placement route to boost its Tier 11 capital and provide for future assets growth. Bank of India's bond issue, on the other hand, ran into rough weather when it offered a coupon of 12.5 per cent at a time when ICICI Bank and some other private banks were offering 13-13.5 per cent on bondsof similar tenure. So, banks have been forced to take mainly the bonds route to raise Tier 11 capital.

Bankers feel that since unfavourable market conditions rule out the possibility of their approaching the market to raise fresh Tier 1 capital, it is imperative to boost Tier 11 capital through a variety of structured options. For example, while bonds impose a regular interest burden outflow on banks irrespective of profits generated, in the case of preference shares dividend is linked to income.

Cumulative convertible preference shares, a hybrid instrument, are instruments where conversion into pure equity takes place after a pre-determined period. Not only is it possible to raise monies without an interest outgo, it is also possible to keep the pure equity low so as not to depress earnings per share in the short term, while at the same time adding to Tier 1 capital after conversion. An additional advantage is that the instrument can be customised in such a way that no annual dividend need be paid (iffuture perceptions of the markets are bullish). Instead, the accumulated dividend will be deemed as the premium at the time of conversion. The plain vanilla variant also allows for unpaid dividend to be accumulated and carried over from a bad year to the next year.

A senior private sector banker points out that if the future view is bearish, cumulative perpetual preference shares, which are neither convertible nor redeemable, could be another option worth considering once the Act is amended.