The Australian Prudential Regulation Authority (APRA) has announced plans to phase out additional tier-one capital instruments (AT1), commonly known as hybrid bonds.
These securities, popular among retail investors, have been a staple in the Australian market for over a decade. They were introduced globally as a buffer against banking crises, allowing debt to convert into equity when banks face financial distress.
APRA's decision follows a review of hybrid bonds, including the $17.3 billion wipeout of Credit Suisse’s bonds during the bank’s collapse last year. Regulators globally have re-examined the effectiveness of these securities in absorbing losses during times of stress, with APRA deciding that cheaper and more reliable capital options are needed.
Hybrid bonds, listed on the ASX, offer high-yield, franked income to investors, with approximately $40 billion worth of these securities currently in circulation. APRA estimates that 20% to 30% of this amount, between $8 billion and $12 billion, is held by retail investors.
These securities were originally introduced as a response to the 2008 financial crisis. They allow banks to convert debt into equity under certain conditions, aiming to provide a cushion in times of financial turmoil.
However, the Credit Suisse crisis highlighted that hybrid bonds may not perform as expected in real-world crises.
APRA plans to phase out hybrid bonds by 2032, the latest date banks can redeem these securities. In their place, banks will be required to hold more common equity and subordinated debt, adding stability to the financial system. APRA has invited submissions on the proposed changes from industry stakeholders, with final consultations expected next year.
While the phase-out could increase funding costs for major banks by $70 million to $260 million annually, smaller banks might see modest cost reductions. The decision marks a significant shift in APRA’s regulatory approach, aiming to enhance the stability of Australia's banking sector and reduce risks.