(Part IV) Bail-In Regimes – The Key Attributes and Who Is Driving?
What Are Bail-Ins?
A bail-in is when regulators or governments have statutory powers to restructure the liabilities of a distressed financial institution and impose losses on both bondholders & depositors.
Simply stated, a bank bail-in is an attempt to resolve and restructure a bank as a going concern, by creating additional bank capital (recapitalisation) via forced conversion of the bank’s creditors’ claims (potentially bonds and deposits) into newly created share capital (common shares of the bank).
The bail-in is undertaken by a regulatory authority that is vested with powers to execute a previously agreed bailin plan in a very short space of time, possibly over a weekend, so as to keep the bank functioning, and to preserve financial stability as far as possible.
To understand what the bail-in concept of a troubled bank is, it is important to understand what a bank balance sheet is, and what the balance sheet consists of. Simply put, a bank’s balance sheet consists of sources of financing and uses of this financing. At a high level, the sources are shareholders’ equity (shares) and the bank’s liabilities, which consist of lending to the bank by bondholders (bonds) and lending to the bank by depositors (deposits).
The shareholders are the bank’s owners, while the bondholders and depositors are the bank’s creditors. These components constitute the bank’s capital, and in total are known as its capital structure. The bank then lends out and invests its liabilities and refers to them as assets.
Previously, during bank bail-outs, when a bank was failing and the government stepped in, the losses were absorbed by the sovereign states and the risk was transferred to the taxpayer. In a bail-in, during the resolution of the problematic bank, the risk is pushed back to the bank’s shareholders and creditors.
In a bank’s capital structure, the various sources of financing exist in a hierarchy of claims. This is both a hierarchy for repayment when the bank is a going concern, and also in liquidation. Debt resides at the top of the hierarchy for repayment, since bondholders get repaid ahead of equity holders. In a liquidation, the company’s assets are sold and proceeds are paid to senior creditors, subordinated creditors, and then shareholders, in that specific order. If senior creditors take a hit, subordinated creditors get nothing, nor do shareholders, who get wiped out. If subordinated creditors take a hit, shareholders are wiped out.