In the intricate world of banking regulation, Additional Tier 1 (AT1) capital plays a pivotal role in ensuring financial institutions remain resilient against economic shocks. As a core component of a bank’s regulatory capital under Basel III and local frameworks like the Central Bank of Bahrain (CBB) Rulebook, AT1 capital is designed to absorb losses while a bank continues to operate. This blog explores the definition, characteristics, loss-absorbing capacity, distinctions, real-world cases, controversies, and key takeaways.
AT1 capital is a category of regulatory capital under Tier 1 (T1) capital, alongside Common Equity Tier 1 (CET1), as defined by the Basel III framework and adopted by regulators . It consists of high-quality, subordinated financial instruments that banks issue to bolster their capital base. AT1 capital is intended to absorb losses on a going-concern basis, meaning it helps a bank remain operational during financial distress without resorting to liquidation.
AT1 instruments are typically perpetual (no fixed maturity) and include features like discretionary dividends or coupons, making them distinct from traditional debt or equity. They provide a buffer against losses, protecting depositors and ensuring compliance with regulatory capital requirements.
Example : CBB Rulebook CA Module
For instance, the CBB mandates that T1 capital (CET1 + AT1) must be at least 8% of risk-weighted assets (RWA) on a consolidated basis, with AT1 limited to 1.5% of RWA . Capital Adequacy Ratio ( CAR) components must meet or exceed the following minimum ratios relative to total risk-weighted assets:
(a) CET1 must be at least 6.5% of risk-weighted assets at all times;(b) T1 Capital must be at least 8% of risk-weighted assets at all times;(c) Total Capital (T1 Capital plus T2 Capital) must be at least 10% of risk-weighted assets at all times;(d) In addition, conventional bank licensees must meet the minimum Capital Conservation Buffer (CCB) requirement of 2.5% of risk-weighted assets. The CCB must be composed of CET1 and so this gives an aggregate 9% CET1 including the CCB minimum capital requirement;(e) A minimum 10.5% T1 Capital Adequacy Ratio including the above CCB requirement; and(f) A 12.5% minimum Total Capital Adequacy Ratio including the above CCB requirement.
Characteristics of AT1 Capital
AT1 instruments are governed by strict criteria to ensure their regulatory purpose. Based on Basel III standards, key characteristics include:
1. Perpetual Nature: No maturity date, ensuring permanent loss absorption
2. Subordination: Rank below depositors and general creditors in liquidation .
3. Discretionary Payments: Non-cumulative dividends/coupons, cancelable without default)
4. Loss Absorption Mechanisms: Conversion to common shares or write-down at trigger events
5. No Incentives to Redeem: No step-ups or early redemption incentives .
6. Callability:Redeemable after five years with CBB approval and replacement capital
7. Fully Paid-In: No future investor obligations
8. No Credit-Sensitive Features:Coupons independent of bank’s credit standing
These ensure AT1 capital is robust yet flexible, supporting banks during stress while meeting regulatory standards.
Loss-Absorbing Capacity of AT1 Capital
AT1’s loss-absorbing capacity enables banks to withstand financial distress through:
• Conversion to CET1: At trigger events AT1 converts to common shares, boosting CET1 and diluting shareholders .
• Write-Down: Principal is reduced (partially/fully), lowering liabilities and enhancing capital ratios .
What AT1 Capital Is Not
Additional Tier 1 (AT1) capital is distinct from other financial instruments in several key ways. Unlike Common Equity Tier 1 (CET1), which represents pure equity such as common shares and retained earnings, AT1 is a hybrid instrument with debt-like features, such as coupon payments, but still qualifies as going-concern capital .
In contrast to Tier 2 (T2) capital, which has a minimum maturity of five years and is designed for gone-concern loss absorption , AT1 is perpetual and supports banks during ongoing operations .
Unlike traditional debt, AT1 does not guarantee coupon payments, and its principal can be written down or converted into equity under specific conditions, enhancing its loss-absorbing capacity.
Finally, AT1 is subordinated to depositors, meaning it ranks lower in priority during liquidation and lacks the protections afforded to deposits, which are typically safeguarded by deposit insurance schemes.
These distinctions highlight AT1’s unique high-risk, high-reward role.
AT1 : Real-World Cases Highlight benefits and the need for Investor Awareness
Banco Popular Español (2017)
Banco Popular’s €1.25 billion AT1 bonds were written down to zero during its 2017 acquisition by Santander, demonstrating loss absorption without taxpayer bailouts but highlighting retail investor risks.
Deutsche Bank (2016)
Market fears led to AT1 bond price drops, but no trigger was activated. New AT1 issuance restored confidence, emphasizing clear trigger communication.
Credit Suisse Case Study (2023)
In March 2023, Credit Suisse faced a severe liquidity crisis and depositor run, rendering it non-viable and prompting Swiss regulators to orchestrate its acquisition by UBS for CHF 3 billion. As part of this intervention, FINMA, Switzerland’s financial regulator, invoked an emergency ordinance to write down CHF 16 billion (approximately $17 billion) of Credit Suisse’s AT1 bonds to zero, prioritizing systemic stability over standard procedures. Notably, this write-down occurred without the bank’s CET1 ratio falling below the typical trigger threshold , highlighting FINMA’s preemptive authority under Swiss law. Controversially, shareholders received CHF 3 billion in UBS shares, effectively inverting the traditional capital hierarchy where equity typically absorbs losses before AT1 instruments. This decision triggered significant market shock, leading to a global sell-off of AT1 bonds and increased yields as investors reassessed the risks associated with these instruments. Bondholders, including institutional and retail investors, initiated legal challenges against FINMA and UBS, arguing that the write-down violated Basel III principles, which prioritize equity loss absorption. The case prompted heightened regulatory scrutiny, with the EU and UK issuing clarifications that AT1 bonds should absorb losses only after equity is fully depleted, distancing themselves from the Swiss approach. The Credit Suisse episode demonstrated AT1’s effectiveness in absorbing substantial losses to protect taxpayers and depositors, but FINMA’s regulatory discretion significantly eroded investor trust, fueling calls for standardized trigger mechanisms to enhance predictability and fairness in AT1 frameworks globally.
The case has ignited debates surrounding AT1 capital, revealing several critical issues . The inconsistent application of the capital hierarchy, where Credit Suisse’s shareholders were partially compensated while AT1 bondholders faced total losses, has sparked uncertainty among investors, challenging the expected loss absorption order outlined in frameworks . Mis-selling of AT1 bonds to retail investors, who often misunderstood the high risks, as seen in cases like Banco Popular and Credit Suisse, has led to stricter sales regulations to protect non-professional investors. The variability in trigger levels, with banks permitted to set thresholds above the Basel III minimum of 5.125% , creates unpredictability, prompting demands for standardized triggers to improve transparency. Market volatility persists, with higher AT1 bond yields reflecting diminished investor confidence following the Credit Suisse fallout, making capital-raising more costly for banks. Additionally, FINMA’s preemptive write-down, bypassing standard trigger events, has raised concerns about regulatory discretion undermining the contractual terms of AT1 instruments, highlighting the need for clearer global guidelines to ensure predictability and fairness.
Key Takeaways
Additional Tier 1 (AT1) capital serves a critical role in the banking sector by acting as a vital buffer that absorbs losses during financial distress, thereby safeguarding depositors and maintaining systemic stability, as demonstrated in high-profile cases like Banco Popular Español in 2017 and Credit Suisse in 2023.
However, the loss-absorbing features of AT1 instruments, such as conversion to common shares or write-downs triggered by events like a CET1 ratio falling below predefined triggar, render them inherently high-risk, necessitating cautious consideration by investors who must be fully aware of the potential for significant losses. The regulatory framework governing AT1 imposes strict criteria—such as perpetual nature, subordination, and discretionary coupons—to ensure robustness, but the complexity of these instruments demands transparent communication to stakeholders to avoid misunderstandings.
The Credit Suisse case, where AT1 bonds were written down to zero while shareholders received partial compensation, exposed contentious issues around capital hierarchy and regulatory discretion, fueling reforms to address inconsistencies and restore investor confidence. The evolving landscape of AT1 regulation, driven by ongoing controversies and market reactions, is pushing for standardized trigger mechanisms and enhanced investor protections to balance financial stability with fairness, restoring trust and shaping the future of this critical capital component in global banking
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