APRA finalises changes to phase out Additional Tier 1 capital instruments

The Australian Prudential Regulation Authority (APRA) has finalised consequential amendments to its bank prudential framework to phase out Additional Tier 1 (AT1) capital instruments – also known as hybrid bonds – as eligible regulatory capital.

APRA confirmed in December last year its decision to phase out AT1, enabling the benefits of:

• improved stabilisation in a crisis and reduced contagion risk. International experience has shown that AT1 capital does not fulfil a stabilising function in a crisis due to the complexities of using it and the risk of causing contagion;
• enhanced proportionality by lowering the cost of capital for smaller banks relative to larger banks; and
• reduced compliance costs for banks by simplifying the framework and removing a capital instrument that can impose additional design, marketing and issuance costs, particularly for small banks.

APRA will allow banks to replace AT1 predominantly with cheaper and more reliable forms of capital that would absorb losses more effectively in times of stress. This will lead to a simpler and more reliable capital framework, with lower costs for smaller banks.

Existing AT1 will be phased out gradually to ensure an orderly transition and limit any immediate impacts on issuers or investors. APRA expects all AT1 issued by banks to be phased out by 2032. There will be no changes to the existing legal terms, including subordination, of these outstanding instruments.

The main change from the initial proposal is that APRA will set the leverage ratio at 3.25 per cent of Common Equity Tier 1 (CET1) capital (rather than 3.5 per cent of CET1). This will maintain the current calibration of the leverage ratio, incorporating industry feedback.

APRA Member Therese McCarthy Hockey said: “This release concludes our multi-year review of AT1, which aimed to address concerns from international experience where AT1 didn’t operate as intended due to the complexity of using it as going concern capital, the potential for legal challenges and the risk of causing contagion.

“By phasing out AT1 as eligible bank capital and replacing it with simpler and more effective regulatory capital instruments, the Australian financial system will be more resilient and better able to withstand future shocks.

“We look forward to continuing our engagement with industry to support a smooth transition onto the new framework, which comes into effect on 1 January 2027.”

APRA has today published a letter to banks that responds to submissions to its consultation on proposed changes to its prudential standards, prudential practice guides and reporting standards to facilitate the phase-out of AT1.

The response letter and new prudential standards, prudential practice guides and reporting standards are available at: Improving the effectiveness of Additional Tier 1 capital instruments.