The Australian Prudential Regulation Authority (APRA) is proposing changes to phase out Additional Tier 1 (AT1) bonds within the capital framework of banks.
APRA said that the proposed changes, outlined in a discussion paper released on September 10, seek "to support financial system stability at times of crisis with simpler and more certain resolution of banks in the unlikely event of failure". They are also aimed at reinforcing confidence in the safety of deposits at times of stress.
APRA is proposing that banks phase out the use of AT1 capital instruments, also called hybrid bonds, and replace them with "cheaper and more reliable forms of capital that would absorb losses more effectively in times of stress". The total amount of regulatory capital that APRA requires banks to hold would remain unchanged.
The announcement comes after shareholder anger following UBS's shot gun takeover of Credit Suisse in March 2023, with many AT1 bondholders of Credit Suisse seemingly unprotected. Many are still trying to recover their money via international arbitration claims. $17.6 billion of the bonds were written down to a zero by Swiss regulators.
The APRA announcement follows a consultation process that began with the release of a discussion paper in September 2023 asking for feedback on improving the effectiveness of AT1 for use in a potential bank stress scenario.
After receiving feedback from 26 submissions and more than 40 engagements, APRA identified three potential options: maintaining the status quo, redesigning AT1 to make it operate more effectively when required, or replacing AT1 with other existing, more reliable forms of capital.
APRA chair John Lonsdale said in the APRA statement: “The purpose of AT1 is to stabilise a bank so that it can continue to operate as a going concern during a period of stress, and support resolution with the capital that is needed to prevent a disorderly failure.”
He continued: “Unfortunately, international experience has shown that AT1 does not fulfil this function in a crisis situation due to the complexity of using it, the potential for legal challenges and the risk of causing contagion. These risks are heightened in the Australian context due to the unusually high proportion of AT1 held by retail investors.”
Lonsdale said: “Replacing AT1 with more reliable forms of capital will enable banks to more quickly and confidently use their capital buffers in a crisis scenario and is expected to reduce compliance costs for banks. It will also strengthen the proportionality of the prudential framework by embedding a simpler approach to capital requirements for small and mid-size banks compared to the new requirements for large banks.”
Under APRA’s proposed approach, large, international banks would be able to replace 1.5% AT1 with 1.25% Tier 2 and 0.25% Common Equity Tier 1 (CET1) capital. Smaller banks would be able to fully replace AT1 with Tier 2, with a reduction in Tier 1 requirements.
APRA has proposed commencing the transition to the new capital framework from January 1, 2027, with all current AT1 on issue expected to be replaced by 2032. For existing investors, APRA said that it doesn't envision an immediate impact with AT1 capital instruments continuing to be eligible as regulatory capital until their first call dates. APRA is not proposing changes to AT1 settings for insurers.
A two-month discussion period has now commenced and APRA said that it welcomes stakeholder feedback on the framework design, expected impacts, and other implementation considerations.
APRA also announced an organisational change to its supervision structure earlier this month and announced a 2024-25 corporate plan.
APRA has moved to having its five industry supervision groups being managed in two supervision divisions instead of the current three frontline supervision divisions – banking, superannuation and insurance (encompassing general, life and private health insurance).
From September 2, APRA's two frontline supervision divisions are: a general insurance and banking division; and a life insurance, private health insurance and superannuation division.
In addition, APRA will bring together its existing financial and non-financial risk teams in a cross industry risk division, alongside teams focused on systemic risk work.
APRA’s three other divisions – policy & advice; technology & data, and chief of staff & enterprise services – remain broadly unchanged.
