Definition
A bail-in is a financial term that refers to the process whereby a business’s creditors or bondholders bear some losses in order to stabilize the firm. It is often used for failing banks where creditors are forced to shoulder some burdens to prevent the bank from going bankrupt. The aim of a bail-in is to prevent system-wide repercussions and keep the institution operational.
Key Takeaways
- A Bail-In is a strategy used by governments and financial institutions to prevent a collapsing bank from affecting the larger financial system, by having the bank’s creditors and depositors take a loss on their holdings.
- This term emerged as an alternative to government-funded ‘bailouts’ post global financial crisis, to avoid the taxpayers bearing the burden of failing banks. Instead, major stakeholders and shareholders of the banking organization are at risk.
- The main objective of the Bail-In methodology is to quickly recapitalize the banks to ensure survival, while maintaining market stability and perpetuating regulatory requirements by means of forcing losses on investors and large depositors.
Importance
A “bail-in” is a critical term in finance used to refer to the rescue of a financial institution that is on the brink of failure, where its creditors and depositors bear some of the burden by having a portion of their debts written off.
This method is in contrast to a taxpayer-funded “bailout.” The concept of a bail-in is significant as it allocates the cost of rescuing a failing financial institution more to the private sector, particularly to creditors who stood to gain if the institution was successful, rather than allowing all burden to fall on taxpayers.
It represents a shift in responsibility and can be seen as a more equitable solution.
Conversely, it can cause more instability in finance markets, as investors bear higher risk; in turn, it can directly affect the economy and individual financial security.
Explanation
A bail-in is a financial strategy that primarily aims to rescue an ailing or failing financial institution by making its creditors and depositors bear the burden of the loss. Instead of the entity being saved using external parties’ funds or government money (also known as a bail-out), an internal restructuring is done to salvage the situation.
Bail-ins serve as a powerful corrective measure to prevent systemic risks and maintain financial stability without causing undue burden on taxpayers. This strategy is used in situations where the failure of a large financial institution poses potential risks for the financial system as a whole.
By converting the debt into shares, the losses of a failing financial institution are absorbed, thereby restoring its viability. One of the fundamental usages of bail-ins is to prevent the “too big to fail” problem, which essentially refers to the belief that certain financial institutions are so large and interconnected that their collapse would be disastrous to a greater economic system.
Therefore, through a bail-in, the financial institution can be prevented from failing without resorting to using public funds.
Examples of Bail-In
Cyprus Bail-In 2013: The European Union and the International Monetary Fund agreed to a 10 billion euro bailout deal for Cyprus. As part of this agreement, a bail-in procedure was carried out on unsecured depositors. Individuals with over €100,000 in Cyprus’s two biggest banks (Laiki Bank and Bank of Cyprus) had to relinquish a portion of their deposits to help recapitalize the banks. This was a significant example of a bail-in being utilised during a financial crisis.
Portuguese banking crisis 2014: After the Portuguese central bank identified a massive hole in Banco Espirito Santo’s finances, it used a bail-in to prevent a banking collapse. The bank was split into a good bank and a bad bank, and junior bondholders and shareholders were forced to swallow losses in order to make up for the bank’s capital shortage. Unsecured depositors were spared, which is a hallmark practice of the bail-in system.
Italian banking crisis 2015-2016: When four small Italian banks (Banca delle Marche, Banca Popolare dell’Etruria, Cassa di Risparmio di Ferrara and Cassa di Risparmio di Chieti) failed in November 2015, the Italian government conducted a bail-in to rescue them. The bail-in required bondholders, many of whom were ordinary savers and small businesses, to take losses. This sparked controversy and widespread protests in the country.
FAQs about Bail-In
1. What is a Bail-In?
A bail-in is a strategy that prevents taxpayer-funded bailouts of failing banks by giving bank regulators the power to restructure distressed banks. It requires creditors and depositors to absorb the losses first before any public funds are used.
2. How does a Bail-In work?
In the event of a bank failure, a bail-in strategy converts the debt of the bank into equity for stabilization. This process essentially diminishes the liabilities of the failed bank while avoiding the need for a government bailout.
3. Are deposits safe during a Bail-In?
Consumer deposits are typically safe during a bail-in, to an insured amount. For instance, in the EU and the U.S., deposits up to a certain limit ($250,000 in the U.S.) are protected by the Federal Deposit Insurance Corporation (FDIC). However, deposits above the insured limit may not be safe.
4. What is the difference between a Bail-In and a Bailout?
A bailout is when an entity, usually the government, saves a failing company by providing financial assistance. A bail-in, on the other hand, allows the failing company to be rescued by its own stakeholders by converting their debt into equity.
5. When was the concept of Bail-In introduced?
The concept of a bail-in was introduced after the 2008 global financial crisis, as part of a solution to reduce government expenditures in financial crises and to prevent the bankruptcy of major financial institutions.
Related Entrepreneurship Terms
- Debt Restructuring
- Insolvency
- Financial Stability Board (FSB)
- Bank Resolution
- Systemically Important Financial Institution (SIFI)
Sources for More Information
- Investopedia: This website provides definitions, explanations, and examples for a range of financial terms and concepts, including ‘Bail-In’
- Bloomberg: Bloomberg.com offers a unique blend of international business and finance news. They often publish articles and economic analyses that delve into concepts such as ‘Bail-In’
- Reuters: Renowned for its coverage of business, finance, and international news, Reuters could offer articles or news items related to the term ‘Bail-In’.
- The Economist: This international weekly newspaper covers a wide range of topics from international news to finance and economics, and could offer detailed insight into the concept of ‘Bail-In’.
