APRA outlines plans for banks to dump hybrid notes by 2032

The prudential regulator has warned the capital notes are too popular with retirees, with the financial system at risk.

APRA chair John Lonsdale. Picture: Chris Pavlich/The Australian

Banks will be forced to close out their popular hybrid bonds and replace the assets with different forms of capital under a major shake-up proposed by the prudential regulator.

The Australian Prudential Regulatory Authority told banks on Tuesday it was likely to recommend they stop issuing hybrid notes by 2032, noting their popularity with retirees posed a danger to the broader banking system.

The move has been met with caution by the banks, who said it represented a significant change to the financial system.

APRA said it was making the move after tumult in the international banking system last year, with the collapse of Silicon Valley Bank and the near death of Credit Suisse.

In Credit Suisse’s case regulators intervened to wipe out holders of its hybrid notes and force UBS to take over its Swiss rival.

APRA said phasing out AT1 (additional tier-1) hybrid notes would allow banks to put in place “cheaper and more reliable forms of capital” aimed at absorbing losses during times of stress to the financial system.

The total amount of regulatory capital banks would be required to hold would remain the same under the proposed changes, with APRA noting the system would remain “unquestionably strong”.

The proposal comes after months of consultation with the banking sector.

APRA identified three options, including redesigning or replacing the AT1 notes, or doing nothing.

But APRA chair John Lonsdale said the AT1 notes failed to provide the padding needed in a crisis.

“The purpose of AT1 is to stabilise a bank so that it can continue to operate as a going concern during a period of stress, and support resolution with the capital that is needed to prevent a disorderly failure,” he said.

“Unfortunately, international experience has shown that AT1 does not fulfil this function in a crisis situation due to the complexity of using it, the potential for legal challenges and the risk of causing contagion.” Mr Lonsdale said Australia had a higher risk of problematic fallout from the AT1 notes due to their take-up by an “unusually high proportion” of retail investors. Many retirees purchased the notes for their consistent yields.

Citi analysts said APRA’s proposed changes would see banks lose their capacity to stream franking credits to retail investors.

Australia's four big banks Commonwealth, Westpac, NAB, ANZ. Picture: NCA Newswire

Mr Lonsdale said replacing the notes with a more reliable form of capital would “enable banks to more quickly and confidently use their capital buffers in a crisis scenario, and is expected to reduce compliance costs for banks”.

“It will also strengthen the proportionality of the prudential framework by embedding a simpler approach to capital requirements for small and mid-size banks compared to the new ­requirements for large banks,” he said.

APRA said it proposed to replace the AT1 notes with either Tier 2 equity or Common Equity Tier 1 capital.

Smaller banks would be able to replace the AT1 notes with tier 2 equity and would see a reduction in Tier 1 equity requirements.

APRA’s changes would not affect insurers using AT1 notes.

APRA said under its proposed road map, notes would be replaced starting in January 2027, with all notes replaced by 2032.

The Australian Banking Association, representing the country’s largest lenders, said APRA’s outlined scheme would represent a “significant change to a bank’s capital structure”.

“Banks will now carefully consider the implications of APRA’s proposal, balancing any changes to costs of capital, as well as impacts on capital markets and investors,” a spokesman said.

The Customer Owned Banking Association welcomed the move, which recognised small and mid-sized banks.

COBA and the smaller lenders have for years complained about the different capital rules applying to Australia’s biggest lenders.

COBA chief executive Michael Lawrence said APRA’s proposal to simplify capital frameworks “could make it easier for our sector to meet our capital requirements, empowering customer-owned banks’ ability to grow and compete – ultimately ensuring Australians can benefit from a dynamic and competitive banking sector”.

“Growing capital is critical to ensure customer-owned banks can scale up while also meeting regulatory requirements,” he said.

Originally published as APRA outlines plans for banks to dump hybrid notes by 2032