Critical reflections on bank bail-ins

Abstract

Many of the world's developed economies have introduced, or are planning to introduce, bank bail-in regimes that involve the participation of bank creditors in bearing the costs of restoring a failing bank to health. There is a long list of actual or hypothetical advantages attached to the bail-in process. Therefore, there is a need for a closer examination of the bail-in process, if it is to become a successful substitute to the unpopular bailout approach. The bail-in tool involves replacing the implicit public guarantee, on which fractional reserve banking has operated, with a system of private penalties. The bail-in approach may, indeed, be much superior to bailouts in the case of idiosyncratic failure. In other cases, the bail-in process may entail important risks. The article provides a legal and economic analysis of some of the key potential risks bail-ins may entail both in the domestic and cross-border contexts. It explains why bail-in regimes will not eradicate the need for injection of public funds where there is a threat of systemic collapse, because a number of banks have simultaneously entered into difficulties, or in the event of the failure of a large complex cross-border bank, unless the failure was clearly idiosyncratic.