Global regulators and investors are increasingly focused on ensuring banks can withstand financial shocks without destabilizing the broader economy. One instrument gaining attention in this context is the Financial Loss-Absorbing Capacity (FLAC) note, designed to provide banks with a buffer that converts debt into equity under distress, helping absorb losses before taxpayers are exposed.
FLAC notes, sometimes referred to as “bail-in bonds,” are debt securities issued by banks with a specific mandate: they can be written down or converted into equity if a bank’s capital falls below a predetermined threshold. Unlike traditional bonds, which obligate issuers to repay principal and interest, FLAC notes are structured to support the bank’s solvency during periods of severe financial stress.
The concept emerged after the 2008 global financial crisis, when governments spent trillions to rescue failing banks. Policymakers and regulators sought ways to protect the financial system while reducing reliance on public funds. FLAC notes became part of a broader framework of contingent capital instruments aimed at strengthening banks’ resilience. In Europe, similar instruments are governed under the Bank Recovery and Resolution Directive (BRRD), while in the United States, regulators encourage large banks to hold comparable loss-absorbing instruments as part of their Total Loss-Absorbing Capacity (TLAC).
Africa’s First FLAC Note
Standard Bank Group Ltd. has completed Africa’s first-ever issuance of Financial Loss-Absorbing Capacity (FLAC) notes, raising 2 billion rand ($123.76 million) in a deal that drew strong investor demand. The issuance shows the growing interest in innovative capital instruments across emerging markets, offering a blueprint for other African banks seeking to meet regulatory resilience requirements while diversifying funding sources.
Mechanics of FLAC Notes
FLAC notes function through clearly defined triggers. When a bank’s regulatory capital ratio falls below a specified level, usually set by central banks or financial authorities, the notes can automatically convert to common equity or be permanently written down. This mechanism injects capital into the institution at the moment it is most needed, preventing insolvency or a liquidity crunch from spreading through the financial system.
For investors, FLAC notes carry higher risk than senior debt because they rank below ordinary bonds in the repayment hierarchy during liquidation. To compensate, banks typically offer higher yields, making them attractive to yield-seeking investors willing to take on contingent risk. The higher interest rates reflect both the subordinated nature of the debt and the possibility that principal could be reduced or wiped out entirely in a stress scenario.
From an accounting perspective, these instruments count toward a bank’s capital buffer, helping satisfy regulatory requirements for loss-absorbing capacity. Regulators assess FLAC notes alongside other forms of capital to determine a bank’s resilience in adverse scenarios. Because the notes are designed to absorb losses before equity is wiped out, they enhance market confidence in the bank’s ability to remain operational under duress.
Market Adoption and Investor Appetite
The adoption of FLAC notes has been gradual but steady. In Europe, major banks including HSBC Holdings Plc and Deutsche Bank AG have issued contingent convertible bonds (CoCos), a category that overlaps with FLAC-style instruments. In Asia, banks such as DBS Group Holdings Ltd. and Mitsubishi UFJ Financial Group Inc. have also explored contingent capital structures to comply with TLAC mandates.
Investors range from hedge funds and asset managers to insurance companies seeking high-yield opportunities with built-in loss-sharing mechanisms. However, the notes require sophisticated risk assessment. Because conversion or write-down can be triggered by regulatory judgment rather than market conditions alone, investors must evaluate not just the creditworthiness of the issuer, but also regulatory frameworks and resolution rules in the relevant jurisdiction.
Benefits and Risks
FLAC notes provide a pre-committed source of capital for banks during stress events, reducing the likelihood of government intervention. They also diversify funding sources, lowering reliance on traditional deposits or equity issuance. For regulators, FLAC notes create a credible mechanism to stabilize banks without resorting to bailouts, addressing concerns that surfaced during past crises.
However, misaligned triggers or insufficient market liquidity can undermine effectiveness. During periods of stress, FLAC notes may rapidly decline in value, creating losses for investors. Moreover, complexity in the legal framework and differing national regulations can affect execution during a crisis, potentially delaying capital absorption.
Jefferson Wachira is a writer at Africa Digest News, specializing in banking and finance trends, and their impact on African economies.