AT1 capital: Reforms to strengthen going-concern role
A BIS FSI Brief argues Additional Tier 1 (AT1) instruments fail their primary going-concern role. The paper proposes reforms to strengthen their loss-absorption function.
Design flaws undermine AT1's primary role
Additional Tier 1 (AT1) instruments are intended to absorb losses as going-concern capital, helping banks restore financial health before resolution.
However, their effectiveness is undermined by low trigger thresholds, discretionary activation, and insufficient incentives for recapitalisation.
The writedown of Credit Suisse's AT1 in March 2023 demonstrated this, as instruments only activated at the point of non-viability, not during recovery.
This functional gap creates uncertainty, prompting policymakers to either phase out AT1 or reform it.
The argument for reform hinges on whether a well-designed AT1 can truly support early recapitalisation.
Current designs fail to provide sufficient incentives for shareholders to inject fresh equity, leading to delayed action.
This paper examines how these critical shortcomings can be addressed to ensure AT1 fulfills its intended role.
Triggers too late for recovery
For AT1 to support recovery, losses must be imposed early through clear mechanisms.
The Basel Framework mandates AT1 features like perpetual nature and loss absorption, with capital-linked triggers at a minimum of 5.125% CET1 (often 7%).
These thresholds, however, appear too low.
Global systemically important banks (G-SIBs) often face CET1 requirements exceeding 10%.
By the time a bank's CET1 ratio falls to 7% or 5.125%, significant buffers are depleted, making fresh equity extremely challenging.
The Credit Suisse case demonstrated this, as AT1 only absorbed losses at the point of failure, not during recovery, indicating current triggers activate too late for effective stabilization.
A critical design flaw
This analysis starkly reveals that AT1's current design is fundamentally flawed for its primary going-concern purpose.
Relying on triggers that activate only at the point of non-viability defeats the entire objective, effectively transforming AT1 into a 'gone-concern' instrument.
Without significant reforms, AT1 risks remaining a source of uncertainty rather than stability, potentially forcing regulators to consider phasing it out entirely.