This report does not constitute a rating action.

We are not changing our issuer credit ratings or hybrid ratings on Australian banks despite a projected decline in our risk-adjusted capital (RAC) ratios due to the phase-out of additional Tier 1 (AT1) hybrid instruments.

Starting in 2027, the Australian banking regulator will reclassify AT1 instruments as Tier 2 capital. This reflects a view that the instruments are widely held by retail investors, and that it would be highly challenging for the regulator to successfully convert AT1s to loss-absorbing capital, even in a stress scenario. The ultimate view is that the instruments may not be useful for absorbing losses on a going-concern basis, and therefore not effective in saving a faltering bank.

The reclassification creates complications. We only include AT1 capital instruments in the RAC ratio for banks so long as they are treated as Tier 1 capital by the regulator, which will no longer be the case at the start of 2027.

Investors are asking us about the likely impact of this important regulatory shift on our ratings on Australian lenders. In short, there will be no ratings impact; we don't believe this change negatively reflects on the fundamentals or the core strengths of rated institutions. Nevertheless, we wanted to carefully walk through our thinking, which we outline in this FAQ.

Frequently Asked Questions

Why are we looking at rating changes now?

Our ratings are forward-looking; however, they also require a level of certainty. In our capital and earnings assessment, we project and rate to the RAC ratios for all banks 18-to-24 months into the future.

On Dec. 9, 2024, the Australian Prudential Regulation Authority (APRA) provided us with certainty around the date from which AT1 instruments will cease to be recognized as Tier 1 capital from a regulatory perspective. That date is Jan. 1, 2027, and falls within our 18-to-24-month timeline. We expect the banks to redeem each AT1 instrument at its first call date and largely replace them with Tier 2 instruments, thus preserving bank regulatory ratio levels.

Furthermore, all four Australian major banks have now reported their half-year results following APRA's Dec. 9, 2024, announcement. They have not announced any significant changes to their current capital-management strategies, which is to largely manage common equity Tier 1 (CET1) capital above 11.0% This level exceeds the current regulatory minimum of 10.25%, which is set to increase to 10.50% on Jan. 1, 2027. Furthermore, all four major banks either have completed or remain committed to completing their previously announced on-market share buybacks.

What is the background to the changes in our ratings construct for ANZ and NAB?

On Dec. 9, 2024, APRA finalized its policy changes to phase out AT1 instruments as eligible bank capital in Australia, from Jan. 1, 2027. From that date, APRA will classify AT1 instruments issued by Australian banks as Tier 2 capital. S&P Global Ratings includes AT1 capital instruments in its RAC ratio for banks so long as they are treated as Tier 1 capital by the regulator.

We do not recognize Tier 2 capital instruments in our RAC ratio. As a result, from Jan. 1, 2027, the RAC ratios of all banks in Australia that use AT1 instruments in their capital structures will fall.

While the RAC ratios of most Australian banks that use AT1 will remain in the range consistent with their current capital and earnings assessment, we project that the RAC ratios of Australia and New Zealand Banking Group Ltd. (ANZ; AA-/Stable/A-1+) and National Australia Bank Ltd. (NAB; AA-/Stable/A-1+) will fall to between 9.0% and 9.5% in 2027. This is below our 10% threshold for their current strong capital and earnings assessment.

Nevertheless, we affirmed our ratings on ANZ and NAB given our views around the strength and quality of their capital management as well as their earnings capacity and quality. The ratings of all other Australian banks, including Commonwealth Bank of Australia (CBA; AA-/Stable/A-1+) and Westpac Banking Corp. (AA-/Stable/A-1+), remain unchanged.

Why do we include AT1 instruments in our RAC ratio but not Tier 2 instruments?

We believe that bank AT1 instruments can play a role to absorb losses and preserve cash on a going-concern basis and recapitalize or resolve a bank that is no longer viable--both through the contractual terms and the powers that authorities have in a stress scenario. Whereas Tier 2 instruments can only absorb losses when a bank is no longer viable. Given their going-concern loss-absorbing capacity, we are of the view that AT1 instruments are closer to CET1 and thus include them in our RAC calculation.

Table 1

Forecast for Australian banks with AT1 instruments in their capital structure
		S&P Global Ratings' RAC ratio before diversification (%)
	Base year	Base year	Prior year	2025F	2026F	2027F	AT1 as a % of TAC	Capital and earnings assessment
Commonwealth Bank of Australia	Jun-2024	11.6	11.9	11.4 - 11.9	11.2 - 11.7	10.0 - 10.5	13.2	Strong
Westpac Banking Corp.	Sep-2024	12.5	12.8	11.5 - 12.0	11.3 - 11.8	9.8 - 10.3	15.1	Strong
Australia and New Zealand Banking Group Ltd.	Sep-2024	10.7	12.1	10.1 - 10.6	10.0 - 10.5	8.9 - 9.4	12.4	Strong
National Australia Bank Ltd.	Sep-2024	11.3	11.4	10.8 - 11.3	10.3 - 10.8	9.1 - 9.6	15.2	Strong
AMP Bank Ltd.	Dec-2024	18.8	17.2	17.9 - 18.4	17.9 - 18.4	15.3 - 15.8	16.4	Very Strong
Macquarie Bank Ltd.	Mar-2024	13.6	13.5	12.8 - 13.3	12.2 - 12.7	10.5 - 11.0	10.5	Strong
Bank of Queensland Ltd.	Aug-2024	13.9	15.5	13.8 - 14.3	13.6 - 14.1	11.9 - 12.4	12.2	Strong
Bendigo and Adelaide Bank Ltd.	Jun-2024	14.4	14.2	14.2 - 14.7	13.8 - 14.3	11.7 - 12.2	13.7	Strong
Judo Bank Pty. Ltd.	Jun-2024	18.7	18.8	16.7 - 17.2	16.1 - 16.6	14.9 - 15.4	4.5	Very Strong
HSBC Bank Australia Ltd.	Dec-2024	12.5	13.3	12.4 - 12.9	10.8 - 11.3	10.7 - 11.2	12.2	Strong
ING Bank (Australia) Ltd.	Dec-2024	13.5	14.1	13.1 - 13.6	12.9 - 13.4	14.1 - 14.6	7.8	Strong
Norfina Ltd.	Jun-2024	13.7	13.6	13.5 - 14.0	13.6 - 14.1	12.2 - 12.7	12.3	Strong
Capital and earnings assessment ranges:
- Adequate	7% - 10%
- Strong	10% - 15%
- Very strong	>15%

Why are we removing AT1 instruments from our RAC calculation as of Jan. 1, 2027?

Under our hybrid capital methodology, we do not include AT1 instruments in our capital calculation if they are not included in regulatory capital. APRA's decision to exclude AT1 instruments from regulatory capital stems from its view that conversion of these instruments to loss-absorbing capital could prove problematic in a banking crisis due to the high level of retail investors holding such investments in Australia.

Additionally, AT1 instruments will be called at their first call date without being replaced by an instrument of a similar quality. Instead, we expect the banks to replace called AT1s largely with Tier 2 instruments. As a result, they will no longer be a permanent component of the capital structure, which is essential for us to evaluate and treat them as equity-like instruments in our RAC calculation.

Calling the instrument at its first call date also ensures that the A$43 billion in Australian bank-issued AT1 instruments outstanding exit the system in an organized fashion.

Why did we affirm our ratings on ANZ and NAB?

Our fiscal 2027 projected RAC ratios for all the other banks in Australia that utilize AT1 within their capital structures remain consistent with our current capital and earnings assessment on them even following the removal of the AT1s within our forecast RAC ratios--see table 1. As such, the ratings on all other banks in Australia that utilize AT1s within their capital stack remain unchanged.

In the case of ANZ and NAB, our projected RAC ratios for fiscal 2027 (year ended Sept. 30) fall below 10%, the threshold for the current strong assessment. Nevertheless, we have utilized flexibility within our rating criteria to maintain the strong assessment for ANZ and NAB's capital and earnings in line with our current assessment.

In our view the strength and quality of both ANZ's and NAB's capital and earnings will remain strong relative to the other banks with a RAC ratio below 10% even after the AT1 instruments are phased out. We believe this to be the case based on several credit factors explained below.

What is our view on the strength and quality of capital and capital management of the Australian major banks?

AT1 instruments will remain until 2032 but their contribution to banks' RAC ratios will fall steadily. While no longer considered as regulatory capital from Jan. 1, 2027, the banks' AT1 securities afford them loss-absorbing capacity on a going-concern basis, which we have not captured in our RAC ratio from Jan. 1, 2027.

We believe that AT1 instruments will behave as per their contractual terms and that the loss-absorbing capacity of the instruments will remain until they are called at their first call dates, the last of which is in 2032. As previously noted, regulatory qualification of AT1 instruments as Tier 1 capital is a crucial factor for us to consider when incorporating the instruments as capital in our RAC ratios. As the outstanding AT1s are gradually called between now and 2032, we will continue to monitor the Australian banks' capital management outcomes, including their forecast RAC ratios, relative to each other and international peers.

Our assessment of a bank's creditworthiness, including its capital and earnings, considers quantitative and qualitative factors. For example, we may adjust the initial capital and earnings score for a bank based on:

• The strength and quality of its capital, which includes the degree to which TAC is made up of common equity;
• And its earnings capacity and quality.

This is the approach we have taken with respect to the ANZ and NAB ratings. Most fundamentally, our rating actions on ANZ and NAB take a substance-over-form approach.

We could have maintained the stand-alone credit profiles (SACPs) for ANZ and NAB by utilizing other areas of flexibility in our criteria. For example, we consider our capital and earnings and risk position assessments holistically. As such, we could positively adjust our risk position assessment by one notch if we were of the view, for example, that our RAC calculation overstated the risks of a particular bank. This application is used for certain banks in some other jurisdictions, such as Canada.

Furthermore, we have an option to apply an adjustment of up to one notch (in either direction) to arrive at a bank's SACP to capture a more holistic view of its creditworthiness. This could be used in a situation where we believe risk or other elements are not adequately captured in our specific factor assessments.

The Australian major banks will continue to maintain prudent CET1 buffers. Historically, the major banks have managed their CET1 ratios with a sound buffer over the minimum regulatory requirement. Prior to APRA finalizing its AT1 paper most major banks announced a target CET1 range of 11.0% to 11.5%, aligning with the regulator's expectation. However, in practice, due to the uncertain environment created by the pandemic and geopolitical tensions, their CET1 ratios have exceeded their target range. We expect this to continue, particularly in the current uncertain global operating environment. As of their most recent reporting dates, the Australian major banks' CET1 ratios were well above the current 10.25% regulatory minimum and above their stated targets. These ratios are strong relative to international peers.

We also believe that the capital targets for major banks will align with the 0.25% increase in the CET1 capital requirement set for Jan. 1, 2027. Only NAB has announced a revised capital target since APRA finalized its AT1 position in December 2024. At its half-year results on May 7, 2025, NAB restated its capital target to a CET1 ratio above 11.25% from its previous 11.0% to 11.5% range. The change considers the 25 basis points increase in Australian major banks' minimum regulatory CET1 ratio as of Jan. 1, 2027, when APRA will cease to recognize AT1 instruments.

Table 2

Most recent published CET1 ratios
	Most Recent Reporting Date	CET1 Ratio
Australia and New Zealand Banking Group Ltd.	March 31, 2025	11.8%
Commonwealth Bank of Australia	March 31, 2025	11.9%
National Australia Bank Ltd.	March 31, 2025	12.0%
Westpac Banking Corp.	March 31, 2025	12.2%

The approach of Australian major banks to capital management is on par with that of international peers. All four Australian major banks have established internal capital adequacy assessment processes (ICAAPs) in accordance with regulatory requirements. The banks have integrated the ICAAPs into their strategic planning, stress testing and risk appetite frameworks. The ICAAPs inform their capital buffer settings. As a result, we believe thoughtful and prudent capital management is deeply embedded within the banks' operations. In this context, the use test is important, as major banks utilize return on risk-adjusted capital as an internal metric to allocate capital among business units, assess risk-adjusted performance, and inform pricing and strategic decisions.

We consider Australia's prudential regulatory standards to be more stringent than other Basel III jurisdictions. For example, APRA is the only prudential regulator that requires banks using an internal risk-based approach for regulatory capital measurement to hold a Pillar 1 capital charge against interest rate risk in the banking book. Moreover, APRA is the sole global prudential regulator transitioning away from AT1 instruments to simplify the going-concern loss-absorbing capital structure.

The regulator's "unquestionably strong" capital stance and strength of the banks' CET1 ratios also place the Australian major banks in the top quartile of global peers. "Unquestionably strong" capital levels follow recommendations from the 2014 Financial System Inquiry (Murray Inquiry) with the goal of ensuring that Australian banks' capital positions can support financial system stability and confidence.

Why did we not adjust our capital and earnings assessment on CBA and WBC to reflect the strength and quality of its capital and earnings too?

While we are of the view that all four Australian major banks have equally strong and high-quality capital and earnings, the RAC ratios of CBA and WBC remain just above the 10% threshold for a strong assessment in fiscal 2027. This makes the differential to the next higher capital and earnings assessment, above 15%, too significant for us to apply a qualitative adjustment.

What is our view on the quality of earnings of the Australian major banks, in particular ANZ and NAB?

ANZ and NAB's profitability will likely remain good by international standards . As of March 31, 2025, ANZ had a return on assets of 0.59% while NAB's was 0.71%. This compares with an average return on assets of 0.65% for Australian and international peers. This gives both banks the ability to absorb losses and build capital through stable earnings.

Net interest income, a more stable source of income than market sensitive income, has contributed an average of 80% to revenue for the two banks over the past five years. This is strong relative to international peers that have averaged 60% over the same period. We also note that a material proportion of revenues are from the retail mortgage segment that is relatively stable, low risk and well secured.

This is unlike some international peers that have exposures to volatile investment banking activities or exotic financial products with similar levels of capitalization. The structure of the Australian major banks, including ANZ and NAB, allows for a more predictable low risk revenue stream, minimizing the impact of market fluctuations on overall income.

The long-term earnings volatility of Australian banks, including ANZ and NAB, is more stable than international peers'. This suggests a more stable earnings environment for these institutions relative to global banks, supporting the strength of their earnings. Australia's banking sector is dominated by four major banks, which limits competition and helps sustain stable profit margins. This market dominance also provides pricing power and predictable revenue streams for the major banks, reducing earnings volatility.

Finally, major Australian banks demonstrate a strong capacity to generate capital. This is reflected in their high dividend payout ratios of about 70% over the past five years, in contrast to an average of around 50% among international peers.

Why is there such a big difference in the forecast RAC ratios of the Australian major banks?

The regulatory CET1 ratios of all four major banks are very similar (see table 2), yet there is almost a 1% difference in our RAC ratios for those same banks. This is because under our capital framework, the risk weights we apply to corporate exposures are more stringent than those used in the regulatory framework. We apply a single risk weight for a wide variety of corporate risks. The broad category for corporate exposure includes direct exposure to corporate entities, income-producing commercial real estate, purchased receivables, and project finance. Given that ANZ and NAB both have higher corporate exposures (including small and midsized enterprises) than CBA and WBC, the RAC ratios of the former two banks are lower (see chart below).

Chart 1

Related Research

• National Australia Bank 'AA-/A-1+' Ratings Affirmed; Outlook Stable, May 15, 2025
• Australia and New Zealand Banking Group Ltd. 'AA-/A-1+' Ratings Affirmed; Outlook Stable, May 15, 2025

Primary Contacts:	Nico N DeLange, Sydney 61-2-9255-9887; nico.delange@spglobal.com
	Lisa Barrett, Melbourne 61-3-9631-2081; lisa.barrett@spglobal.com
	Gavin J Gunning, Melbourne 61-3-9631-2092; gavin.gunning@spglobal.com