The changes seek to enhance financial system stability
The Australian Prudential Regulation Authority (APRA) has proposed changes to the capital framework for banks, aimed at simplifying and improving the effectiveness of capital instruments during a crisis.
The changes, outlined in a discussion paper the regulator has published, seek to enhance financial system stability and reinforce confidence in the safety of deposits.
APRA is recommending that banks phase out Additional Tier 1 (AT1) capital instruments, also known as hybrid bonds, in favour of cheaper and more reliable capital forms that can absorb losses more effectively during periods of stress. The overall amount of regulatory capital that banks are required to hold would remain unchanged, with banks continuing to be considered “unquestionably strong.”
The proposal stems from lessons learned during last year’s global banking instability, which saw several banks in the US and Europe either fail or require government intervention. APRA’s changes aim to ensure that similar scenarios are managed more effectively in Australia, particularly by addressing the complexity and risks associated with AT1 capital.
According to APRA chair John Lonsdale (pictured above), replacing AT1 with more reliable capital forms would better protect depositors and the financial system in the event of a bank failure.
“International experience has shown that AT1 does not operate effectively in a crisis due to its complexity and potential for legal challenges, which can increase the risk of contagion,” he said. “This is particularly concerning in Australia, where a high proportion of AT1 is held by retail investors.”
The proposed changes would allow large, internationally active banks to replace 1.5% of their AT1 with a combination of 1.25% Tier 2 capital and 0.25% Common Equity Tier 1 (CET1) capital. Smaller banks would be allowed to fully replace AT1 with Tier 2 capital, with a reduction in Tier 1 requirements.
APRA has proposed a gradual transition starting from January 1, 2027, with the goal of fully replacing AT1 by 2032. Existing AT1 instruments will remain eligible as regulatory capital until their first call dates, and APRA does not expect an immediate impact on investors. The proposed changes do not apply to insurers.
APRA has also opened a two-month consultation period, inviting feedback from stakeholders on the proposed framework and its potential impacts.
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