Investing in a Bank

There are a number of ways to invest in a Bank, including investing in Hybrids. Some are simple and very common. Others, like Hybrids, are complex and more risky, but may pay higher distributions to investors. Money invested in a Bank helps fund its activities, such as lending to households and businesses.

Introducing Hybrids

Hybrids (including Tier 1 Hybrids and Tier 2 Notes) are the focus of this website. These securities are called “hybrids” because they contain some features typical of debt investments, and some features typical of equity securities (Ordinary Shares). Banks issue Hybrids primarily to meet specific capital requirements imposed by APRA and to fund their activities.

There are a variety of reasons why investors may choose to include Hybrids in their investment portfolio.

These include the potential, in certain market conditions, for Hybrids to offer:

  • higher yields than other less risky investments in a Bank (such as term deposits); and
  • lower volatility than Ordinary Shares.

Hybrids may also appeal to investors as they may be able to be traded on the ASX.

Hybrids also carry specific risks of which investors should be aware. In certain circumstances, Hybrid investors may lose all or a significant amount of their investment.

Ways to Invest in a Bank

The table below describes some common types of investments in a Bank, including Hybrids, and some of their typical features. The terms of particular investments may vary.

Savings Accounts Savings accounts include transactional, savings and cheque accounts.  These accounts allow an investor to withdraw their money at any time and tend to offer a very low rate of interest, if any.  

Term deposits

Term deposits are savings accounts with a fixed term, which are typically between one month and five years. In return for “locking away” an investor’s money for a set period, term deposits tend to pay a higher rate of interest compared to savings accounts.

Senior debt

Senior debt takes various forms, such as “senior bonds”, “commercial paper” or “certificates of deposit”, which generally pay a fixed or floating (also known as variable) rate of interest, and are usually repayable on a fixed date between one month and 10 years from issuance.  These securities are referred to as “senior”, because, if a Bank is wound up, the investor is entitled to be repaid before Hybrid investors and holders of Ordinary Shares. Banks generally do not issue senior debt to retail investors.

Hybrids

Hybrids may take the form of:

  • Tier 2 Notes, often called “subordinated notes”
  • Tier 1 Hybrids, often called “capital notes” or “convertible preference shares”

Banks issue Hybrids primarily to meet specific capital requirements imposed by APRA and to fund their activities.

Ordinary Shares

Ordinary Shares entitle investors to a share in the ownership of the Bank. In the event of failure of the Bank, Ordinary Shares carry no right to return the capital to investors until all higher ranking claims have been paid. Investors may receive dividends at the Bank’s discretion and have a right to vote at general meetings of the Bank’s shareholders. Ordinary Shares of most Banks can generally be traded on the ASX.

Ranking and subordination

If a Bank becomes insolvent and is wound up, there will be an order in which funds available at that time are distributed to investors. The table above summarises the order of repayment (otherwise known as ranking) in a winding up, with investments at the top of the table repaid before investments at the bottom.

Claims in respect of Hybrids are “subordinated” to claims in respect of most other investments in a Bank, such as senior debt and deposits, which are “unsubordinated”. This means that, in a winding up of the Bank, claims in respect of Hybrids will only be repaid after prior ranking claims have been paid in full, and only to the extent that sufficient funds remain.

Whilst Hybrid investors may receive a higher yield than unsubordinated investors, if the Bank becomes insolvent, Hybrid investors face a greater risk that they will lose some or all of their investment.

Hybrids are not protected under the Financial Claims Scheme

The Financial Claims Scheme may apply to some forms of investment in a Bank if the Bank is in severe financial difficulty. Investors should be aware that Hybrids are not protected under the Financial Claims Scheme.

Comparing the key features of common investments in a bank

 

Protected under the Financial Claims Scheme

Usual term

Early redemption at the Bank’s option

Payments during the term

 Tradeable on the ASX

Loss Absorption – Conversion or Write-Off

Savings Accounts

Yes

No fixed term – repayable at call

Not applicable

Floating rate interest, if any

No

No

Term Deposits

Yes

Typically between 1 month and 5 years

No

Fixed rate interest

No

No

Senior Debt

No

Typically between 1 month and 10 years

Terms may permit early repayment at the option of the Bank (or the investor)

Generally fixed or floating rate interest

Generally, no

No

Tier 2 Notes

No

Typically around 10 years, subject to conditions

Yes, subject to APRA approval

Typically, floating rate interest, non-discretionary, subject to Solvency Condition

Generally, yes

Yes, if a Non-Viability Trigger Event occurs (unless APRA requires only Tier 1 Hybrids to be Converted or Written-Off)

Tier 1 Hybrids

No

Perpetual, with Mandatory Conversion, subject to conditions

Yes, subject to APRA approval

Typically franked, floating rate, discretionary distribution, subject to Payment Restrictions

 Generally, yes

Yes, if a Non-Viability Trigger Event or Common Equity Trigger Event occurs

 

Ordinary Shares

No

Perpetual

Not applicable

Typically franked, discretionary distribution

Yes

No

Hybrid securities education