Are Additional Tier 1 (AT1) instruments actually functioning as going-concern capital — or have they become, in practice, a gone-concern tool?
The Financial Stability Institute’s (FSI) latest report warns that the sector has never been stress-tested through a severe economic downturn, leaving leverage and borrower credit quality vulnerabilities untested. Key concerns include deepening ties between private credit funds and banks (direct exposures estimated between $220 billion and $500 billion); borrowers that are generally more leveraged and of lower credit quality than in public markets, with early signs of stress emerging; valuation opacity through complex, multi-layered structures and reliance on private ratings; and liquidity mismatches in funds offering investor redemptions. Data gaps across jurisdictions further hinder effective oversight.
The brief identifies three design failures that undermine AT1’s going-concern role: trigger thresholds are set too low relative to banks’ actual capital requirements; writedown mechanisms transfer value to shareholders rather than imposing costs on them; and the discretionary nature of activation means authorities typically intervene too late to support recovery.
The authors propose a reform path centred on three elements: conversion at sufficiently dilutive, variable, and market-linked prices as the primary loss-absorption mechanism; elimination of writedown and discretionary going-concern triggers; and CET1-linked triggers calibrated high enough — potentially above 10% — to activate while recovery remains feasible. The brief also weighs potential drawbacks, including higher funding costs for banks, reduced buffer usability, and implications for resolution funding.
