Author: Ryan van Breda
South Africa’s bail-in bonds that can bite back
South Africa’s banks are gearing up for significant issuances – a shift that could reshape listed credit markets and redefine future bank funding curves. We unpack the structure, risks, and market implications of First Loss After Capital (FLAC) instruments – and what it all means for investors.
A new era for bank resolution in South Africa
South Africa’s banks are poised for a significant shift with the introduction of FLAC instruments – additional bail-in bonds designed to strengthen the financial system and reshape the credit investment landscape. This evolution presents institutional investors with new opportunities and unique risks.
Enhancing loss absorption through FLAC instruments
Prompted by lessons from the global financial crisis, regulators worldwide have implemented frameworks to minimise taxpayer-funded bank bailouts. The Financial Stability Board (FSB) developed a framework for managing the failure of systemic financial institutions, emphasising adequate loss-absorbing capacity to minimise the need for public bailouts. To mitigate the use of public funds during crises, regulators introduced Total Loss-Absorbing Capacity (TLAC) standards, allowing them to “bail-in” banks by cancelling or converting debt held by investors into equity during financial distress. This approach aims to protect taxpayers while ensuring financial stability.
In South Africa, the Prudential Authority has introduced FLAC Instruments under Prudential Standard RA03, aiming to provide adequate loss-absorbing and recapitalisation capacity for systemically important financial institutions (SIFIs). The domestic regulator applies international TLAC principles to these banks and their holding companies. SIFIs designated by the Governor of the Reserve Bank currently include Absa Bank Limited, Capitec Bank Limited, FirstRand Bank Limited, Investec Bank Limited, Nedbank Limited and The Standard Bank of South Africa Limited.
Figure 1: Simplified capital structure with loss-absorbing capital
Source: Perpetua Research and BIS
Defining characteristics of FLAC instruments
New instruments that are to be issued by the ultimate bank holding company.
· These instruments differ to vanilla senior unsecured bank bonds, as those bonds are issued by the operating bank entity.
· The instruments are fully paid, unsecured, but now are required to have a minimum initial maturity of 24 months to be FLAC compliant.
· Instruments are required to have a minimum remaining maturity of 12 months, implying that these instruments are callable 12 months prior to maturity.
· Instruments prohibit early redemption by the issuer and acceleration clauses.
· Rank junior to other senior unsecured claims but senior to regulatory capital – Common Equity Tier 1 capital (CET1), Alternative Tier 1 (AT1) and Tier 2 (T2) instruments.
· Investors are required to acknowledge bail-in risk by the regulator within resolution.
Understanding the creditor hierarchy:
FLAC Instruments rank:
· Below senior unsecured creditors;
· Above regulatory capital instruments (CET1, AT1, T2); and
· This “non-preferred senior” position means FLAC Instruments, during resolution, absorb losses after regulatory capital is exhausted but before impacting other unsecured creditors.
Figure 2: FLAC instrument ranking in the creditor hierarchy
Source: Perpetua Research and Standard Bank Research
FLAC
Instruments are structurally subordinated, given where they are issued.
Structural subordination occurs because the holding company’s debt ranks below
that of its subsidiaries, as creditors of the subsidiaries have first claim on
the assets of those subsidiaries. Therefore, the holding company’s ability to
meet its financial obligations will depend on receipt of interest and principal
repayments on loans made by it to its subsidiaries and/or distributions of
earnings and capital received from its subsidiaries in the form of dividends,
distributions or other advances and payments from time to time.
It is notable
that the market has yet to price in this risk. For example, FirstRand Bank
Limited is currently the only registered bank issuing all its JSE-listed
regulatory capital instruments directly from the bank’s own balance sheet. In
contrast, peers issue from their listed holding companies, introducing an
additional layer of structural subordination. Investors in FirstRand’s
instruments are therefore exposed to lower subordination risk, which should
translate into a tighter risk premium and allow the issuer to achieve more
competitive funding. Yet, current pricing shows no distinction between
instruments with different issuance entities and subordination profiles. We
expect that, once FLAC instruments enter the market, investors will begin to
demand additional premiums to reflect subordination risk accordingly.
Figure 3: Structural subordination risk
Source: Perpetua Research
The risks: bail-in mechanics and investor impact
Bail-in within
resolution: Activated when a bank enters resolution. FLAC
Instruments are bailed-in only after CET1, AT1 and T2 regulatory capital
instruments have first absorbed losses.
No
acceleration/event of default: Like AT1 and T2 regulatory
capital instruments, Investors do not have acceleration rights or event of
default rights, meaning instruments continue according to original terms.
Market impact and investment opportunity
The initial
FLAC issuance requirement is substantial, ranging between R288-R360 billion.
Given existing JSE listed vanilla senior unsecured bank bonds of c. R206billion
in August 2025, a shortfall of R81-R153 billion suggests considerable issuance
opportunities and likely higher yields to compensate for structural and legal
uncertainties. Phasing occurs from 1 Jan 2026 over a 6-year period.
In early FLAC
issuance phases, investors should require additional yield spreads compared to
existing senior bank bonds, reflecting structural subordination, bail-in risk
and the volume required. Over time, these spreads may establish a new, elevated
“senior” base funding curve – leading to a structural uplift in bank
bond credit spreads. We believe this repricing will influence broader credit
market spreads including for corporates, SOEs, and other issuers in time.
Looking forward
As South Africa transitions to this new resolution framework – regulatory clarity, fairness, and transparency will be crucial for maintaining investor confidence. Institutional investors must carefully evaluate AT1 and T2 regulatory capital instruments, the FLAC structure, creditor hierarchies, and bail-in risks both pre-resolution and during resolution.
Unlike AT1 and T2 instruments, which can be bailed-in at a pre-resolution trigger (Point of Non-Viability), FLAC instruments are bailed-in solely during resolution. In resolution, statutory creditor hierarchies apply, ensuring creditors are treated no worse than in liquidation. The requirement for concurrence between the Prudential Authority and the Reserve Bank prior to any pre-resolution bail-in is an essential safeguard to AT1 and T2 instrument holders, though legal and procedural uncertainties remain. As active stewards of client capital, we proactively engage the relevant regulators to advocate for a credible, transparent, and fair resolution regime that should preserve creditor hierarchies pre and in-resolution.