What Is a Bail-In?
A bail-in offers vital relief to financial institutions on the brink of collapse by mandating the cancellation of liabilities owed to creditors and depositors. Unlike a bailout, which involves external parties, such as governments, using taxpayer funds, a bail-in internalizes the financial rescue, placing the burden on creditors.
Key Takeaways
- A bail-in aids a financially distressed institution by canceling debts owed to creditors and depositors.
- Both bail-ins and bailouts are strategies employed during a financial crisis.
- Bailouts avoid creditor losses, while bail-ins do the opposite.
- Globally, bail-ins are increasingly considered to mitigate taxpayer burdens in financial crises.
Understanding Bail-In
Bail-ins and bailouts arise from necessity and offer mechanisms to help institutions during crises. While bailouts were heavily utilized during the 2008 Financial Crisis, bail-ins hold a noteworthy position as an alternative. In a distressed scenario, investors and deposit-holders usually prefer a bail-in to safeguard the institution’s solvency and avoid complete loss of investments or deposits.
Governments generally strive to prevent a financial institution’s failure to avoid systemic market problems. This concern was evident during the 2008 Financial Crisis when the refrain ’too big to fail’ spearheaded significant financial reforms.
Requirements for a Bail-In
Even though investors commonly know about bailouts, economists also strategically employ bail-ins. For instance, Europe uses bail-ins to address some of its toughest economic challenges. The Bank of International Settlements (BIS) has specifically highlighted bail-ins for integration in the European Union.
Typically, bail-ins are employed in the following scenarios:
- The financial institution’s failure won’t cause systemic problems or ’too big to fail’ issues.
- Governments lack the financial resources necessary for a bailout.
- Resolutions frameworks necessitate bail-ins to minimize taxpayer expenditure.
In the U.S, deposits are protected by the Federal Deposit Insurance Corporation (FDIC), insuring each bank account for up to $250,000. In a bail-in, financial institutions would only tap into deposits exceeding this insured amount.
Real-World Examples of Bail-In
The Cyprus Experiment
The general public became widely aware of bail-ins in 2013 when authorities implemented this strategy with the Bank of Cyprus, a known offshore tax haven. Uninsured depositors (defined in the European Union as having deposits exceeding 100,000 euros) faced significant losses but received bank stock in return, although the stock value didn’t compensate for most of their losses.
European Union
Since 2018, the European Union has been exploring the broader inclusion of bail-ins within its resolution strategy. Fernando Restoy from the Bank for International Settlements elaborated on these efforts in a notable speech. A new EU framework might integrate both bail-ins and bailouts, proposing that a specified amount of funds be written off during the initial resolution phase before activating a bailout.
Related Terms: creditor, bailout, financial institution, bankruptcy, systemic risk, FDIC insurance.
