A bank bail-in is a financial rescue procedure in which a failing bank’s creditors and depositors are forced to bear some of the losses incurred by the bank rather than taxpayers or the government. This means that if a bank is in danger of failing, it will use its own funds to recapitalise itself rather than rely on external funding.
In a bail-in, the bank’s creditors and depositors may be required to write off a portion of their claims on the bank or convert them into equity in the bank. This helps to ensure that the bank has enough capital to continue operating while protecting taxpayers from having to bail out the bank with public funds.
The idea behind a bank bail-in is to incentivise banks to be more prudent in their risk-taking since they know that they and their investors, rather than taxpayers, will bear the cost of any losses. It also aims to reduce the risk of systemic financial crises by making banks more resilient and less likely to fail.
History of bank bail-ins
The concept of a bank bail-in originated in the global financial crisis of 2008, which exposed the weaknesses in the traditional approach of using taxpayer funds to bail out failing banks. This approach was criticised for transferring the costs of the banks’ risky behaviour onto the public while leaving the banks’ management and shareholders largely unaccountable.
In response to this criticism, the European Union adopted the Bank Recovery and Resolution Directive (BRRD) in 2014, which introduced the bail-in tool to deal with failing banks. The BRRD requires EU member states to establish national bank resolution authorities with the power to impose losses on a bank’s shareholders and creditors in the event of a crisis before resorting to any external financial assistance.
The bail-in concept was subsequently adopted by other countries, including Canada and Switzerland, and has become part of the international policy framework for dealing with failing banks. The Financial Stability Board, which coordinates global financial regulation, has also endorsed using bail-ins to reduce the risk of systemic financial crises.
Since its introduction, the bail-in tool has been used in several cases, including the resolution of banks in Italy and Spain. It has been generally seen as a more effective and equitable approach to dealing with failing banks than the traditional bailout approach.
Examples of successful bank bail-ins
There are several examples of bank bail-ins that have been successful in resolving failing banks while minimising the costs to taxpayers. Some notable examples include:
- Banco Popular, Spain (2017): In June 2017, Banco Popular, one of Spain’s largest banks, was declared “failing or likely to fail” by the European Central Bank (ECB). The Spanish authorities then used the bail-in tool to transfer the bank’s assets and liabilities to Banco Santander, with shareholders and junior bondholders in Banco Popular losing their investments. This prevented the need for a taxpayer-funded bailout and allowed the bank to continue operating.
- Banca delle Marche, Banca Popolare dell’Etruria, Banca Popolare di Vicenza, and Veneto Banca, Italy (2015-2017): In 2015, four small Italian banks – Banca delle Marche, Banca Popolare dell’Etruria, Banca Popolare di Vicenza, and Veneto Banca – were placed under special administration due to financial difficulties. The Italian authorities used the bail-in tool to convert the banks’ junior debt into equity and to impose losses on shareholders while preserving the depositors’ funds. The four banks were then merged into a single entity, Banca IFIS, which was recapitalised by private investors.
- Co-operative Bank, UK (2013): In 2013, the Co-operative Bank, a UK-based mutual bank, faced financial difficulties due to losses incurred by its acquisition of Britannia Building Society. The bank used the bail-in tool to convert £1.3 billion of its bonds into equity while also raising additional capital from its shareholders. This prevented the need for a taxpayer-funded bailout and allowed the bank to continue operating under new ownership.
These examples show that bail-ins can be an effective tool for resolving failing banks while minimising the costs to taxpayers. However, it’s worth noting that bail-ins can also negatively affect investors and creditors and create uncertainty in financial markets.
Examples of unsuccessful bank bail-ins
There are some instances of bank bail-ins that were unsuccessful in achieving their intended goals or had negative consequences for investors or the wider economy. Some notable examples include:
- Cyprus Popular Bank, Cyprus (2013): In 2013, Cyprus Popular Bank (also known as Laiki Bank) was declared insolvent and was subject to a bail-in as part of a broader rescue package for the Cypriot banking sector. Depositors with over €100,000 in the bank had their funds frozen and were subject to haircuts on their deposits, while shareholders and bondholders lost their investments. The bail-in led to protests and a run on the country’s banks and negatively affected the Cypriot economy.
- Banco Espirito Santo, Portugal (2014): In 2014, Banco Espirito Santo, one of Portugal’s largest banks, was declared insolvent and was subject to a bail-in that imposed losses on bondholders and shareholders. However, the bank’s problems were too severe, and a subsequent bailout was required to support the bank’s resolution. The bailout involved using government money and was controversial due to concerns about the bank’s governance and risk management practices.
- Heta Asset Resolution, Austria (2016): Heta Asset Resolution, the “bad bank” created to manage the assets of the failed Austrian bank Hypo Alpe Adria, was subject to a bail-in in 2016 that imposed haircuts on bondholders. However, the bail-in was subsequently challenged by affected investors in Austrian and German courts, and the uncertainty surrounding the resolution of the Heta Asset Resolution has had negative consequences for the Austrian banking sector.
These examples show that while bail-ins can be an effective tool for resolving failing banks in some cases, they can also have negative consequences and may not always be successful in achieving their intended goals.
Advantages and disadvantages of bank bail-in over bank bailout
Bank bail-ins and bank bailouts are two different approaches to dealing with failing banks. Below are some of their advantages and disadvantages.
Advantages of bank bail-in over bank bailout:
- Minimises costs to taxpayers: In a bail-in, the bank’s shareholders and creditors absorb the losses rather than taxpayers. This reduces the burden on public finances and avoids the moral hazard problem of banks taking excessive risks knowing that the government will bail them out. It does not socialise losses.
- Avoids creating a perception of unfairness: Bailing out banks can generate a perception of unfairness, as taxpayers may feel that they are bearing the burden of a problem caused by the bank’s management and investors. A bail-in avoids this feeling of unfairness.
- Encourages better risk management: Banks that know they are not “too big to fail” are more likely to operate in a way that avoids excessive risk-taking and encourages better risk management practices.
- Preserves market discipline: Bail-ins maintain market discipline by holding investors accountable for their investments and their due diligence in assessing the bank’s risks.
Disadvantages of bank bail-in over bank bailout:
- May create instability: Bail-ins can create uncertainty in financial markets and potentially lead to a run on the bank, as depositors may withdraw their funds if they fear their deposits will be subject to a bail-in.
- Can have negative consequences for investors: Investors, particularly bondholders and shareholders, will lose some of their investments in a bail-in, which could have negative implications for their personal finances.
- More difficult to implement: Implementing a bail-in can be more complex and time-consuming than a bailout, as it requires careful assessment of the bank’s liabilities and coordination with different creditors.
- Does not restore confidence quickly: A bail-in may not restore confidence quickly in a failing bank compared to a bailout.
Related information
Refer to the related knowledge resources:
- An introduction to bank bailout
- An introduction to assessing the financial strength of banks
- An introduction to fractional reserve banking
- An introduction to discount window borrowing
- An introduction to Common Equity Tier 1 (CET1) capital ratio
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