APRA to phase out AT1 as eligible bank capital

The Australian Prudential Regulation Authority (APRA) has confirmed it will phase out the use of Additional Tier 1 (AT1) capital instruments to simplify and improve the effectiveness of bank capital in a crisis.

Following an extensive consultation process beginning last year and careful consideration of the potential options, APRA launched a consultation in September on a proposal to require banks to replace AT1 – also known as hybrid bonds – predominantly with cheaper and more reliable forms of capital that would absorb losses more effectively in times of stress.

The move is one of a number of changes APRA introduced in response to lessons from last year’s overseas banking turmoil where several US and European banks either failed or required rescue, and where Government intervention was required to restore stability and minimise the risk of contagion. 

APRA has consulted thoroughly on this policy proposal, with 23 written submissions received and discussions with various stakeholders including banks, industry associations, rating agencies, brokers, investors and peer regulators. 

Feedback was generally supportive of APRA’s proposal, with most respondents agreeing that AT1 does not meet the regulatory objectives of stabilising a bank experiencing financial stress or supporting resolution to prevent a disorderly failure. Some submissions did raise concerns with phasing out AT1, noting a range of impacts including investors losing access to AT1 as an investable product. APRA acknowledges these concerns but remains of the view that AT1 does not do effectively what it is intended to do: absorb losses while the bank is a going concern and support resolution. An effective regulatory framework in a crisis is important to safeguard the interests of depositors, limit risks to financial stability, and avoid the need for taxpayer funded support.

As a result, APRA has today written to banks confirming it would proceed with plans to phase out AT1, while laying out a timeline for transitioning to the updated framework over the next eight years. 

APRA Chair John Lonsdale said the purpose of today’s letter was to provide certainty to industry so that banks and other stakeholders could start preparing for the transition. 

“Capital is the cornerstone of the banking system’s ability to withstand financial stress. While Australia’s banks are unquestionably strong, overseas experience has shown AT1 doesn’t operate as intended during a crisis due to the complexity of using it, the potential for legal challenges and the risk of causing contagion.

“By replacing AT1 with forms of capital that are more reliable in a stress situation, Australia’s banks will be even better equipped to respond to a future crisis, minimising the potential need for taxpayer support.

“There will be no overall increase in capital requirements for banks, and we expect funding costs under the new framework will be neutral to marginally higher for the five largest banks and slightly lower for all other banks.

“Overall, we believe the benefits of strengthening the bank prudential framework, reducing compliance costs and enhancing proportionality outweigh any associated costs,” Mr Lonsdale said.

Under APRA’s proposed approach:

• Large, internationally active banks will be able to replace 1.5 per cent AT1 with 1.25 per cent Tier 2 and 0.25 per cent Common Equity Tier 1 (CET1) capital.¹
   
• Smaller banks will be able to fully replace AT1 with Tier 2, with a reduction in Tier 1 requirements.
   
• APRA’s requirements applicable to internationally active banks will remain in line with international minimum standards.

APRA will continue to consult industry on consequential amendments to the prudential framework. APRA intends to finalise changes to prudential standards before the end of 2025, with the updated framework to come into effect from 1 January 2027.

Although APRA expects expect banks with surplus AT1 to replace it with Tier 2 Capital at their next call dates, APRA will consider requests to replace existing AT1 where the replacement does not increase the current level of AT1 capital instruments or extend call dates beyond 2032.

Capital requirements for insurers will remain unchanged.

The letter is available on the APRA website: Improving the effectiveness of Additional Tier 1 capital instruments.

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