Following a consultation period the Australian Prudential Regulation Authority has confirmed that 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.
APRA first proposed the move in September to phase out the use of AT1 capital instruments (often called hybrid bonds, or capital notes) and replace them with cheaper and more reliable forms of capital that would absorb losses more effectively in times of stress.
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.
As a result, APRA has now 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 it wanted to provide certainty to industry so that banks and other stakeholders could start preparing for the transition.
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“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,” Lonsdale said.
“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.”
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.
Although APRA expects 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.
