Bail-In

A bail-in is a method of resolving a failing bank by making its own shareholders and creditors absorb the losses. Instead of the government injecting public money, the resolution authority writes down the value of certain debts or converts them into new shares, rebuilding the bank's capital from within. Deposits up to the insured limit are protected, but bondholders and, in some cases, large uninsured depositors can lose part of their claims.

Bail-in tools were adopted widely after the 2008 financial crisis, when governments spent large sums on bail-outs and public anger focused on the idea that banks were too big to fail. Rules from the Financial Stability Board and laws such as the European Union's Bank Recovery and Resolution Directive now set out who loses money, in what order, when a large bank fails. The approach is meant to reduce moral hazard and protect taxpayers.

Imagine a shop run as a partnership that has borrowed from friends and family. If the shop runs into deep trouble, there are two ways to save it. An outsider, such as the town council, could step in and pay the debts; that is a bail-out. Or the people already involved could agree to turn some of their loans into a share of the business, so the shop owes less and can keep trading; that is a bail-in.

With a bank, the "people already involved" are its shareholders, bondholders and some large depositors. They chose to lend to or invest in the bank and were paid interest for doing so. A bail-in says they, rather than the general public, should carry the cost if things go wrong.

When a supervisor decides a bank is failing or likely to fail and no private solution exists, the resolution authority takes control. It then applies losses in a set order, known as the creditor hierarchy:

1. Equity. Existing shares are cancelled or heavily diluted.
2. Additional Tier 1 and Tier 2 capital. Subordinated instruments designed to absorb losses are written down or converted.
3. Other subordinated debt. Junior bonds follow.
4. Senior unsecured debt. Ordinary bonds can be written down or converted into equity if more capital is needed.
5. Uninsured deposits. In many regimes, deposits above the insured limit rank last among bail-in-able liabilities, with preference for those of individuals and small firms.

Insured deposits, secured liabilities such as covered bonds, and some short-term interbank and payment obligations are generally excluded. The principle of "no creditor worse off" means no one should lose more than they would have in normal insolvency proceedings.

The best-known bail-in took place in Cyprus in March 2013. As part of a rescue agreed with the euro area and the International Monetary Fund, Laiki Bank was wound down and Bank of Cyprus was recapitalised by converting a large share of uninsured deposits above €100,000 into equity. The country also introduced temporary capital controls to stop money leaving. The episode shocked depositors across Europe and became a reference point for both supporters and critics of bail-ins. In 2017, Spain's Banco Popular was resolved under the new EU framework, with its shares and junior bonds written off before it was sold to Santander for one euro. In March 2023, Swiss authorities wrote down about CHF 16 billion of Credit Suisse's Additional Tier 1 bonds as part of its takeover by UBS, while shareholders still received some value, an order that drew legal challenges from bondholders.

The Financial Stability Board's Key Attributes of Effective Resolution Regimes, issued in 2011, called for bail-in powers in all major jurisdictions. Global systemically important banks must also hold total loss-absorbing capacity, a minimum amount of capital and bail-in-able debt that can be written down without touching operating liabilities. In the EU, the equivalent is the minimum requirement for own funds and eligible liabilities, and the directive requires bail-in of at least 8% of a bank's liabilities before a resolution fund can contribute. In the United States, the Orderly Liquidation Authority under the Dodd-Frank Act gives the FDIC powers to impose losses on creditors of large failing firms. These rules sit alongside Basel III capital standards rather than replacing them.

Supporters say bail-ins protect taxpayers and make investors price risk more carefully. Critics raise several concerns. A bail-in in one bank may spark runs on others if creditors fear they are next, which is the very systemic risk it is meant to prevent. Retail investors have sometimes been sold bail-in-able bonds without understanding the risk, as happened in Italy in 2015. Valuations used to decide losses are contested and often end up in court. And in a large crisis, governments may still choose public support, which undermines the credibility of bail-in rules. For depositors, the main lesson is the importance of deposit insurance limits.

• Financial Stability Board
• Single Resolution Board