Australia's Move to Phase Out AT1 Bonds
The Australian Prudential Regulation Authority (APRA) has announced plans to phase out Additional Tier 1 (AT1) bonds as bank capital, following the global banking turmoil triggered by the collapse of Credit Suisse in 2023.
The move marks Australia as one of the first major financial markets to take such decisive action in response to growing concerns about the reliability of AT1 bonds in crisis situations.
The downfall of Credit Suisse, once a powerhouse of global finance, sent shockwaves through the banking sector. A crucial part of its collapse was the complete write-off of $17 billion worth of AT1 bonds during the Swiss government-brokered rescue by UBS. This unprecedented action not only sparked a legal battle but also led to a re-evaluation of the role and safety of AT1 instruments worldwide.
AT1 bonds were originally introduced in the wake of the 2008 Global Financial Crisis as a safety net, designed to convert to equity or be written off during times of financial distress to prevent taxpayer-funded bailouts. However, the Credit Suisse debacle has exposed flaws in this mechanism, raising concerns about their complexity, legal vulnerability, and the potential for market contagion.
APRA’s proposal aims to replace the use of AT1 bonds with more stable and reliable forms of capital that can better absorb losses during a crisis. Starting from January 1, 2027, Australian banks will begin phasing out their AT1 bonds, with the complete transition expected by 2032. The regulatory body is encouraging major banks to substitute 1.5% of their risk-weighted assets currently held in AT1 bonds with 1.25% Tier 2 capital and 0.25% Common Equity Tier 1 (CET1) capital.
Smaller lenders will also be given the flexibility to replace their AT1 instruments entirely with Tier 2 capital, which is seen as more reliable in a financial downturn. The aim is to simplify the resolution process for banks during times of financial instability, reduce legal risks, and, most importantly, protect retail investors—who hold a disproportionately large share of AT1 bonds in Australia.
Australia’s decision draws from the lessons of the 2023 banking turmoil that saw several US and European banks face existential crises. Governments had to intervene quickly to prevent contagion, but the sheer complexity of AT1 bonds meant that their intended role as crisis buffers was not effectively realized. APRA Chair John Lonsdale noted that international experience shows AT1 bonds fail to stabilize banks as intended, largely due to their complexity and legal challenges.
Globally, the AT1 bond market is worth hundreds of billions of dollars, with banks continuing to issue new debt instruments even in the wake of Credit Suisse’s collapse. However, with Australia moving to phase out AT1s, it raises questions about whether other countries will follow suit, or if new forms of hybrid securities will emerge to fill the gap.
Australia’s “Big Four” banks—Commonwealth Bank, Westpac, National Australia Bank (NAB), and ANZ—currently have around A$39 billion in AT1 bond issuance. The transition to Tier 2 capital and CET1 could save these banks nearly A$1 billion in interest payments, while also ensuring that they remain financially resilient in the face of future crises.
For investors, particularly retail investors who hold a large portion of AT1 bonds, this transition provides a more secure form of capital in case of a downturn. However, there may be an initial increase in funding costs as banks adjust to the new regulatory environment.