Hybrid have characteristics most similar to common equity and have been popular with retail investors chasing yield but the prices for some tier 1 bank hybrids have slumped recently.

About $3.5 billion of bank hybrids are being allocated to retail investors, including new issues by Bendigo and Adelaide Bank, Challenger, Commonwealth Bank of Australia and Macquarie Group.

Hybrids are classified as debt but can be written down or converted to equity by regulators in times of crisis and the Reserve Bank of Australia warned on Wednesday that some investors were underestimating the risk of a trigger event.

"A significant reassessment of the risks could impose heavy losses on investors and substantially increase banks' funding costs, especially as this could coincide with increased stress in the banking system," the RBA said.

According to broker Morgans' tier 1 hybrid index, prices are down 1.5 per cent over the past two months.

At the market's close on Wednesday these recent tier 1 bank hybrids were trading below their issue price: ANZ Capital Notes II, NAB CPS I and II; Westpac CPS and Westpac Capital Notes I and II. The ANZ and Westpac securities recovered, closing above par on Thursday.

Evans & Partners' hybrid expert, Michael Saba, said the recent falls were "liquidity driven as the market digests the new issuance. Investors who require funding to buy new paper are selling old issues in a short time frame.

"That window is closing soon, prices will rebound once the funding selling stops."

James Lawrence, a credit analyst from Morgans, agreed that once the new issuance washed through the market, prices of the existing tier 1 instruments were likely to recover. He said the recent fall in hybrid prices presented clients with a buying opportunity.

Fixed income broker FIIG Securities warned of the potential for further drops in the value of bank hybrids over the next few weeks.

"The problem is that these new securities are engineered for a specific purpose, namely to be used to 'bail-in' capital in the event that the banking regulator becomes concerned," said FIIG's head of markets, Craig Swanger.

"This is a post-GFC device that as yet is untested so markets don't know how to price this risk and regulators are still shifting their rhetoric around how they will use their right to force conversion."

The Australian Securities and Investments Commission warned about bank hybrids last year but this failed to stop retail investors piling into recent issues, including the $2.6 billion CBA hybrid known as PERLS VII. This deal settles on September 30.

Australian's position contrasts with Britain's Financial Conduct Authority which this year banned the issue of bank hybrids to retail investors. The European regulator may follow suit.

In its stability review, the RBA also pointed to other risks from bank hybrids, including the potential for hybrid holders to short-sell bank equity "aiming to close their positions with the shares generated at conversion". The central bank also said the type of investor facing losses upon conversion might impact on the regulators' decision to trigger conversion.

Last week ratings agency Standard & Poor's published new methodology for rating hybrids, which FIIG said will lead to downgrades of the ratings on some Australian bank hybrids. (Many of the hybrids sold purely to retail investors are not rated, but so-called tier 2 hybrids purchased institutional investors are.) This is because many fund managers may be forced sellers if they become sub-investment grade, so are not allowed to be held pursuant to their investment mandates.