The Securities and Exchange Board of India (SEBI) on March 10 had directed mutual funds to consider the maturity of so-called AT1 bonds as 100 years for valuation and limit exposure to such bonds to 10% of its debt assets, effective April 1.

In a letter sent to SEBI the next day, the finance ministry asked the regulator to withdraw the valuation rule, saying it will cause "huge" mark-to-market losses, take away the appetite for such instruments and hurt capital raising by state-run banks.

On Monday, SEBI relaxed the rule, saying maturity considered for valuation of AT1 bonds would be 10 years until March 31, 2022. They will be valued as 20-year bonds until Sept. 30, 2022, 30-year papers for the next six months and 100-year papers thereafter.

Currently, the call option date of the bond is considered to calculate the valuation.

Introduced after the 2008 global financial crisis, AT1 bonds have quasi-equity characteristics. They typically carry higher interest rates than more senior debt as investors accept the risk they can lose their investment at certain pre-agreed points if the funds are needed to bolster a struggling bank's capital.

Of the 900 billion rupees ($12.36 billion) worth of AT1 bonds outstanding, about 350 billion rupees is held by mutual funds.

Last year, SEBI restricted investments in such bonds to qualified institutional investors and raised their allotment and trading lot sizes to 10 million rupees after a revival plan for debt-laden Yes Bank saw its AT1 bonds fully written down, sending shockwaves through the industry.

($1 = 72.8125 Indian rupees)

(Reporting by Abhirup Roy; Editing by Dan Grebler)