An evolution in SA's banking resolution

South Africa's six systemically important banks are navigating a structural shift in their capital stack. The introduction of first loss after capital (Flac) instruments under Prudential Standard RA03, effective January 2026, marks a significant change to the South African bank creditor hierarchy.

For institutional investors in bank debt, this is not a peripheral regulatory development — it demands a fresh look at our risk and return assumptions across the entire capital stack. This piece examines the importance of Flac in the resolution framework, key characteristics of Flac instruments, the quantum of Flac to be issued and implementation timeline thereof, and what the early pricing evidence tells us about how the market is beginning to value Flac.

The bank creditor hierarchy

Flac’s position in the bank creditor hierarchy is displayed in Chart 1. Flac instruments are subordinated to operating company (OpCo) senior unsecured liabilities but senior to regulatory capital instruments.

Chart 1: Flac ranks between OpCo senior unsecured liabilities and regulatory capital in the bank creditor hierarchy

Source: Standard Bank research, South African reserve Bank

The regulatory foundation

Where the South African Reserve Bank (“SARB”) has designated a bank as a systemically important financial institution (“SIFI”), both the institution and its holding company must meet minimum first loss after capital (Flac) requirements, in accordance with Prudential Standard RA03: Flac Instrument Requirements for Designated Institutions. The standard came into effect on 1 January 2026, and several SIFI banks have already begun issuing this new class of debt. The six SIFI banks designated by the SARB are: Absa Bank Limited; Capitec Bank Limited; FirstRand Bank Limited; Investec Bank Limited; Nedbank Limited; and The Standard Bank of South Africa Limited.

The importance of Flac in the resolution framework

The resolution framework was introduced through Chapter 12A of the Financial Sector Regulation Act, 2017, as inserted by the Financial Sector Laws Amendment Act, 2021. The resolution regime provisions of Chapter 12A came into effect on 1 June 2023.

At its core, the resolution framework equips the SARB with the tools to manage a failing bank without destabilising the broader financial system, shielding vulnerable depositors and – critically – keeping taxpayers unscathed.

SIFIs require a resolution strategy for the continuation of critical functions due to the impact the failure of these functions can have on the financial sector and the broader economy. For SIFI banks, the SARB’s preferred approach is an open-bank resolution strategy, under which the bank remains operational during resolution and continues to provide critical functions. This contrasts with a closed-bank resolution strategy, which aims to protect depositors by halting operations and relying on mechanisms such as liquidation.

The objective of an effective resolution framework is to ensure that sufficient loss-absorbing and recapitalisation capacity is available in resolution to restore viability during periods of severe stress.

The resolution authority has various resolution tools, including statutory bail-in, which is the primary resolution tool that will be used in an open-bank resolution strategy. Under statutory bail-in, the resolution authority is empowered to write down equity, issue new shares, write down senior unsecured or lower-ranked liabilities or convert those liabilities into equity to recapitalise a failing institution in a manner that respects the creditor hierarchy.

To ensure the availability of sufficient loss-absorbing and recapitalisation capacity in resolution, the Financial Sector Regulation Act, 2017 introduced a new class of unsecured, subordinated debt instruments: Flac. These Flac instruments must be readily available for statutory bail-in during resolution.

Bail-in, not bail-out, is one of the central tenets of the Flac framework. In our view, the mandatory issuance of Flac instruments directly enhances banks' resilience in a crisis, reinforces financial stability, and ensures that, when stress materialises, the impact on taxpayers is reduced.

A key differentiating characteristic between Flac and regulatory capital instruments, additional tier 1 (AT1) and Tier 2, is that Flac can only be bailed in during resolution – much like OpCo senior unsecured liabilities. Regulatory capital can be bailed in at the point of non-viability (PONV), which precedes the point of resolution (POR) in the bank failure timeline.

The PONV is triggered at the earlier of certain quantitative or qualitative triggers – it is effectively when the Prudential Authority determines that a write-off of capital is necessary to prevent the issuing bank or its controlling company from becoming non-viable, or if a public sector capital injection is required to prevent failure. PONV envisages regulatory bail-in (or “contractual” bail-in) as the primary tool to restore viability.

Regulatory bail-in may be applied to AT1 and Tier 2 instruments without any realised losses (apart from dilution) imposed on common equity tier 1 (CET1). In this sense, regulatory bail-in does not follow the creditor hierarchy but instead imposes losses on creditors who have contractually agreed to it, namely AT1 and Tier 2 holders.

This differs from statutory bail-in which strictly follows the creditor hierarchy. For context, the POR is reached once the point of non-viability has been triggered and corrective actions, such as the write-off or conversion of AT1 and Tier 2, are either unsuccessful or considered unlikely to restore the bank’s viability.

Both the Prudential Authority and resolution authority must collectively decide on whether corrective actions would be insufficient to restore viability, at which point the bank moves directly into resolution without exhausting the PONV corrective action process.

In our view, within the South African context, the write-down of regulatory capital instruments (i.e. AT1 and Tier 2) is unlikely to be sufficient to restore market confidence, given their relatively small size in total capital. It is therefore likely that a failing bank would be placed immediately into resolution (POR) before attempting to implement the corrective actions envisaged in PONV.

Chart 2: Simplified path to bank resolution and the regulatory actions available to authorities

Source: Absa Securities, SARB

Core characteristics of Flac instruments

In practice, the intended issuance process operates as follows:

1.        SIFI bank OpCo calculates its minimum Flac instrument requirements.

2.       The ultimate holding company (HoldCo) of the SIFI bank issues Flac to external parties to meet the requirements (“external Flac”).

3.       The HoldCo receives proceeds from this issuance.

4.      The OpCo then issues Flac to the HoldCo (“internal Flac”) on terms that mirror those of the external Flac. This back-to-back arrangement helps to prevent unintended structural subordination on top of the contractual subordination introduced by the creditor hierarchy.

5.       The OpCo receives proceeds of internal Flac.

Unsecured subordinated debt instruments qualify as Flac instruments provided they meet the key eligibility criteria, outlined in Table 1.

Table 1: Key eligibility criteria for Flac instruments

Source: SARB

We believe there is a high probability that banks will call Flac once they reach 12 months to maturity, as the instrument would be considered expensive debt at that point without contributing to minimum Flac requirements.

This dynamic could reduce the universe of investible instruments for money market funds, especially as senior unsecured term paper reaches maturity (senior paper is likely not to be issued during the Flac implementation period).

Scale, sequencing and the six-year build

From the Flac issuance implementation date of 1 January 2026, a six-year phase in period applies to the base minimum Flac requirement (“bMFR”). The first binding requirement is set at 60% at the end of year three (2028), after which the requirement increases annually until reaching 100% in 2031. Further details of the calibration of the bMFR are set out in Prudential Standard RA03.

We estimate the bMFR to be over R300 billion – a figure that is expected to grow alongside total bank assets over the six-year period – which exceeds the volume of maturing OpCo senior unsecured term paper for all SIFIs except Investec. This implies some cannibalisation of longer-term negotiable certificates of deposit (NCDs) and structured note issuance.

The phase-in period noted above does not apply to the idiosyncratic component of the minimum Flac requirement (“iMFR”), which is institution-specific and still to be determined by the SARB once the resolution planning process has reached a mature state.

Pricing: initial expectations and recent auction outcomes

Given its ranking in the creditor hierarchy, Flac should price between senior unsecured and Tier 2 pricing – consistent with pricing observed in comparable jurisdictions. Prior to the inaugural Flac auction (Standard Bank Group Limited on 27 January 2026), our analysis incorporated the factors outlined in Table 2, which reference the spread premium of Flac paper to senior unsecured paper.

Table 2: Factors influencing the Flac pricing premium

It is worth reiterating that senior unsecured paper is itself subject to bail-in risk. In our view, the pricing premium for Flac therefore reflects subordination within the creditor hierarchy, rather than pure bail-in risk. Investors are also likely to price according to expected maturity rather than actual maturity, given the probability of calling Flac instruments at 12 months to maturity.

As at 5 March 2026, four Flac auctions have taken place in the South African market: two issuances from Standard Bank Group Limited (SBG), one issuance from Absa Group Limited (ABG) and one issuance from Nedbank Group Limited (NED). The bars in Chart 3 represent the price guidance of each note, with the clearing spread and subscription ratio also illustrated.

Chart 3: Flac price guidance, clearing spreads and subscription ratios

Source: Futuregrowth calculations

The market initially estimated the Flac spread premium over the most recent auction clearing spreads for senior paper (November 2025) to be in the region of 10bps to 42bps, on a ZARONIA-adjusted basis. This range incorporated international experience, such as the spread between senior preferred and senior non-preferred, as well as the positioning of senior non-preferred in the distance between senior preferred and Tier 2 paper.

Read: JIBAR to ZARONIA: Top questions answered

Given the liquidity in the market coming into the SBG auction on 27 January 2026 – and the fact that this was the first debt capital market auction of the year – it is unsurprising that demand was elevated compared to successive Flac auctions, as represented by the subscription ratios. In all auctions, the notes cleared at or below the lower end of price guidance.

However, what was surprising was that the initial Flac spread premium over senior paper was only 3bps to 4bps – significantly lower than the 10bps to 42bps expectation. We believe this is a function of demand outstripping supply in the debt capital market, the relatively small auction issuance size of R2.2 billion allocated across four notes, and the tight price guidance.

It is worth noting that NCDs compressed by about 5bps from the last senior auction to the inaugural Flac auction and, assuming senior paper followed this compression, this implies a Flac premium of 8bps to 9bps for the inaugural Flac auction – very close to the lower end of the expected premium.

In our view, the market is pricing Flac as if the entire tranche of the six-year implementation period has been issued, and there is a fully-phased-in recovery profile. Despite declining subscription rates, demand remains elevated and spreads have continued to compress following the first Flac auction. Lower subscription rates on the longer-dated notes reflect, in part, higher issuance volumes to meet the issuance requirements.

While early pricing reflects the weight of demand rather than a settled view on subordination, recovery and liquidity risks, the six-year implementation period will see the Flac market deepen considerably — and with it, the opportunity for investors to capture appropriate risk-adjusted returns as price discovery matures.