In a worst-case scenario, where the Australian Prudential Regulation Authority cuts the level of hybrid capital in a bank’s minimum regulatory capital to zero, the big banks would need to raise around A$17 billion of capital, an analyst has estimated. Morningstar analyst Nathan Zaia ran the numbers on possible outcomes from APRA’s proposal to tighten up on the design features of banks’ additional tier 1 capital securities, or hybrids. There could be a significant impact on the banks’ capital positions but not much on earnings. Earlier this month, APRA released a discussion paper looking at whether bank-issued AT1 securities are fit for purpose. It said it was concerned that some current product features and market practices “create significant challenges or potentially undermine” the effectiveness of additional tier 1 capital in absorbing loss. Changes up for discussion include restricting retail investor access to hybrids, changing distribution and loss absorbency rules and reducing the level of hybrid capital in a bank’s minimum regulatory capital. The Morningstar report said: “It is likely APRA will change product terms in an attempt to make it clear to investors and banks that in times of financial stress there is a chance distributions will be missed and AT1 will be converted to equity. “This likely leads to a modest increase in the cost of new issuance but it is not material enough to warrant any adjustment to earnings forecasts or fair value estimates.” “Given that AT1 makes up around 1 per cent of total bank liabilities, we think the impact on funding costs will be relatively minor. Paying an additional 150 bps on hybrids, we estimate the impact on profit would be around 1 per cent.” The major banks have a minimum regulatory capital requirement of 10.25 per cent, with an expectation that the actual level of tier 1 capital will be between 11 and 11.5 per cent. At June 30, Commonwealth Bank had a common equity tier 1 capital ratio of 12.2 per cent. It held $9 billion in excess of the regulatory minimum capital requirement.  At the end of March, ANZ had a tier 1 capital ratio of 13.2 per cent, NAB 12.2 per cent and Westpac 12.3 per cent. Morningstar said that if the banks had to replace all AT1 the current surplus would be wiped out and we estimate banks would collectively need to raise around $17 billion. “We are not assuming this happens but a worst-case scenario,” Morningstar said. APRA has two concerns about hybrids. First, its observation from overseas experience is that rather than acting to stabilise a bank as a going concern in stress, AT1 tends to absorb losses at a very late stage in a crisis. Secondly, the regulator is concerned that Australian banks are outliers internationally in their practice of selling a large part of their AT1 issuance to retail investors.  “This would make it particularly challenging to use AT1 to facilitate the recapitalisation of a bank in resolution, as APRA would be concerned that imposing losses on these investors would bring complexity, contagion risk and undermine confidence in the system in