Bailout vs. bail-in
A bail-in is the opposite of a bail-out because it does not rely on external parties, especially government capital support. A bail-in creates new capital to rescue a failing firm through an internal recapitalization and forces the borrower's creditors to bear the burden by having part of the debt they are owed written off or converted into equity. (For example, in the case of the Cyprus banks in 2013, the creditors in question were bondholders, and the bail-in was of depositors with more than €100,000 in their accounts.)
Theory The bail-in was first proposed publicly in an Economist Op-Ed "From Bail-out to Bail-in" in January 2010, by Paul Calello and Wilson Ervin. It was described as a new alternative between "taxpayer bail-outs (bad) and systemic financial collapse (probably worse)." It envisioned a high-speed recapitalization financed by "bailing-in" (converting) bondholder debt into fresh equity. The new capital would absorb losses and provide new capital to support critical activities, thereby avoiding a sudden disorderly collapse or fire sale, as seen in the
Lehman failure. Management would be fired and shareholders would be displaced by the bailed-in bondholders, but the franchise, employees and core services could continue, supported by the newly converted capital. Around the same time, the
Bank of England was developing similar architecture, given the pressing need for a better tool to handle failing banks during the
2008 financial crisis. The first official discussion of bail-in was set out in a speech by
Paul Tucker, who chaired the
Financial Stability Board (FSB) Working Group on Cross Border Crisis Management and was also deputy governor for Financial Stability at the Bank of England. In March 2010, Tucker began to outline the properties of a new "bail-in" strategy to handle the failure of a large bank: By October 2011, the FSB Working Group had developed this thinking considerably and published the "Key Attributes of Effective Resolution Regimes for Financial Institutions." The document set out core principles to be adopted by all participating jurisdictions, including the legal and operational capability for such a super special resolution regime (now known as "bail-in"). The scope of the planned resolution regime was not limited to large domestic banks. In addition to "systemically significant or critical" financial institutions, the scope also applies to two further categories of institutions Global SIFIs (banks incorporated domestically in a country that is implementing the bail-in regime) and "Financial Market Infrastructures (FMIs)" like clearing houses. The inclusion of FMIs in potential bail-ins is in itself a major departure. The FSB defines those market infrastructures to include multilateral securities and derivatives clearing and settlement systems and a whole host of exchange and transaction systems, such as payment systems, central securities depositories, and trade depositories. That would mean that an unsecured creditor claim to, for example, a clearing house institution or a stock exchange could in theory be affected if such an institution needed to be bailed in. The cross-border elements of the resolution of globally significant banking institutions (G-SIFIs) were a topic of a joint paper by the
Federal Reserve and the
Bank of England in 2012. Outgoing Deputy Director of the
Bank of England Paul Tucker chose to open his academic career at Harvard with an October 2013 address in Washington to the
Institute of International Finance in which he argued that resolution had advanced enough in several countries that bailouts would not be required and so would be bailed-in, notably the US G-SIBs. Although they were still large, they were no longer
too big to fail because of the improvements in resolution technology. In a similar vein, a GAO report in 2014 determined that the market expectation of bailouts for the largest "too big to fail" banks had been largely eliminated by the reforms. That was determined by various methods, especially by comparing the funding cost of the biggest banks with smaller banks that are subject to ordinary FDIC resolution. That differential, which had been large in the crisis, had been reduced to roughly zero by the advance of reform, but the GAO also cautioned that the results should be interpreted with caution. In Europe, the EU financial community symposium on the "Future of Banking in Europe" (December 2013) was attended by Irish Finance Minister
Michael Noonan, who proposed a bail-in scheme in light of the banking union that was under discussion at the event. Deputy BoE Director
Jon Cunliffe suggested in a March 2014 speech at
Chatham House that the domestic banks were too big to fail, but instead of the
nationalisation process used in the case of
HBOS,
RBS and threatened for
Barclays (all in late 2008), those banks could henceforth be bailed in. A form of bail-in was used in small Danish institutions (such as Amagerbanken) as early as 2011, as well as the later conversion of junior debt at the Dutch Bank SNS REALL. However, the process did not receive extensive global attention until the bail-in of the main banks of Cyprus during 2013, discussed below. The restructuring of the Co-op bank in the UK (2013) has been described as a voluntary or negotiated bail-in.
Legislative and executive efforts The
Dodd–Frank Act legislates bank resolution procedures for the United States under Title I and Title II. Title I refers to the preferred route, which is to resolve a bank under bankruptcy procedures aided by extensive pre-planning (a "living will"). Title II establishes additional powers that can be used if bankruptcy is seen to pose "serious and adverse effects on financial stability in the United States", as determined by the Secretary of the Treasury, together with two thirds
Federal Reserve Board and two thirds of the
Federal Deposit Insurance Corporation board. Like Title I, it would force shareholders and creditors to bear the losses of the failed financial company, "removing management that was responsible for the financial condition of the company." The procedures also establish certain protections for creditors, such as by setting a requirement for the payout to claimants to ve at least as much as the claimants would have received under a bankruptcy liquidation. The FDIC has drawn attention to the problem of post-resolution governance and suggested that a new
CEO and
Board of Directors should be installed under FDIC receivership guidance. Claims are paid in the following order, and any deficit to the government must be recouped by assessments on the financial industry: • Administrative costs • The government • Wages, salaries, or commissions of employees • Contributions to employee benefit plans • Any other general or senior liability of the company • Any junior obligation • Salaries of executives and directors of the company • Obligations to shareholders, members, general partners, and other equity holders A number of strategies were explored early on to determine how Title I and Title II powers could be best used to resolve a large failing bank, including "Purchase and Assumption" and "Loss Sharing". Over time, the preferred approach evolved to a bail-in strategy, which is more direct, as it does not require an acquisition party. That approach was developed under the FDIC Office of Complex Financial Institutions group led by James R. Wigand. The approach is described in a slide deck from January 2012 as well as in Congressional testimony. The specific strategy for implementing a bail-in under the Dodd–Frank Act requirements has been described as the "Single Point of Entry mechanism". The innovative FDIC strategy was described by Federal Reserve Governor
Jerome Powell as a "classic simplifier, making theoretically possible something that seemed impossibly complex." It created a relatively simple path by which bail-in could be implemented under the existing Dodd–Frank powers. Powell explained: A comprehensive overview of this strategy is available in the
Bipartisan Policy Center report "Too Big to Fail: The Path to a Solution". The
Canadian government clarified its rules for bail-ins in the "Economic Action Plan 2013", at pages 144–145 "to reduce the risk for taxpayers." The
Eurogroup proposed on 27 June 2013 that after 2018, bank shareholders would be first in line to assume the losses of a failed bank before bondholders and certain large depositors. Insured deposits under £85,000 (€100,000) would be exempt and, with specific exemptions, uninsured deposits of individuals and small companies would be given preferred status in the bail-in pecking order for taking losses. That agreement formalised the practice seen earlier in Cyprus. Under the proposal, all unsecured bondholders would be hit for losses before a bank was allowed to receive capital injections directly from the
European Stability Mechanism. A tool known as the
Single Resolution Mechanism, which was agreed by Eurogroup members on 20 March 2014, was part of an EU effort to prevent future financial crises by pooling responsibility for eurozone banks, known as a banking union. In a first step, the
European Central Bank will fully assume supervision of the 18-nation currency bloc's lenders in November 2014. The deal needed formal approval by the European Parliament and by national governments. The resolution fund would be paid for by the banks themselves and will gradually merge national resolution funds into a common European one until it hits the €55 billion target of funding. See the EC FAQ on the SRM. The legislative item was split into three initiatives by Internal Market and Services Commissioner
Michel Barnier: Bank Recovery and Resolution Directive, DGS and SRM.
Practice A form of bail-in was used in small Danish institutions (such as Amagerbanken) as early as 2011. The Dutch authorities converted the junior debt of
SNS REAAL in 2013, as part of a privately funded recapitalization. During the
2012–2013 Cypriot financial crisis, the Cypriot economy came to near-collapse as the
Greek government-debt crisis (to which Cypriot banks were heavily exposed) threatened Cyprus's banks, causing a
financial panic,
bank runs, and a downgrade of government bonds to "junk" status. In March 2013, a €10 billion bailout was announced by the
European troika, a loose coalition of the
European Union, the
European Central Bank and the
International Monetary Fund, in return for Cyprus agreeing to close its second largest bank, the
Cyprus Popular Bank, also known as Laiki Bank. The Cypriots had to agree to levy all uninsured deposits there and possibly around 40% of uninsured deposits in the
Bank of Cyprus, the island's largest commercial bank. After an initial proposal was replaced with the final proposal, no
insured deposit of €100,000 or less was to be affected. The levy of deposits that exceeded €100,000 was termed a "bail-in" to differentiate it from a government-backed bailout. The Bank of Cyprus executed the bail-in on 28 April 2013. The proposal was amended the following day to affect only uninsured depositors and creditors. In a broader review of the events of Cyprus, Draghi addressed some of the criticism of this event in a press conference: In 2016, Cyprus completed its bailout program, which was successfully implemented. Combined with equity and other capital securities, that establishes an aggregate TLAC of roughly $2 trillion for the eight U.S. G-SIFIs. In the UK, the Bank of England has set out the TLAC requirements for its largest banks, described as MREL, at between 25.2% and 29.3% of
risk-weighted assets. Switzerland has imposed requirements on its two G-SIFIs of 28.6% of risk-weighted assets. The EU is currently debating how best to implement the FSB requirements across its banking system and what the appropriate size of that requirement should be. ==Themes==