Bail-inable debt is the part of a bank's liabilities that a resolution authority has the legal power to write down, or convert into shares, when the bank is failing. The purpose is to make creditors, and not taxpayers, bear losses and provide the new capital needed to keep the bank's essential services running. The holders are mainly institutional investors such as asset managers, insurers and pension funds.
The concept comes from the reforms that followed the financial crisis of 2007 to 2009, when governments rescued banks with public money in a bail-out because imposing losses on creditors through ordinary insolvency was judged too disruptive. The alternative, the bail-in, was set out in the Financial Stability Board's standards for resolution regimes and is implemented in the European Union by the Bank Recovery and Resolution Directive, in the United Kingdom by the Banking Act 2009 as amended, and by comparable laws elsewhere.
Which liabilities are bail-inable
Under the European framework, the bail-in power applies in principle to all liabilities that are not expressly excluded. In practice, the instruments expected to absorb losses are, in order:
- Capital instruments. Common Equity Tier 1 absorbs losses first, followed by Additional Tier 1 capital and Tier 2 capital.
- Other subordinated debt. This covers subordinated debt that does not count as regulatory capital.
- Senior non-preferred debt. This is a class of senior unsecured debt created by law to rank below ordinary senior claims, or debt issued by a holding company so that it is structurally subordinated.
- Ordinary senior unsecured debt. This includes bonds and other unsecured claims and, last of all, deposits above the insurance limit, with those of individuals and small businesses ranking ahead of other deposits.
Losses are applied in the reverse of the ranking that would apply in insolvency, so debt seniority determines who is affected first.
What is excluded
Certain liabilities are protected, either to prevent runs or because bailing them in would defeat the purpose of resolution. The main exclusions under European Union rules are deposits covered by deposit insurance, secured liabilities including covered bonds, client assets and client money, very short-term liabilities to other banks and to payment and settlement systems, and amounts owed to employees, to tax authorities and to suppliers of critical services. The resolution authority may also exclude other liabilities case by case, for example where bail-in could not be done quickly enough or would spread contagion. Insured deposits therefore cannot be written down, although the deposit insurance scheme itself may have to contribute in their place.
Minimum requirements
A bail-in works only if enough suitable debt exists when it is needed. Regulators therefore set minimum amounts. For global systemically important banks, the Financial Stability Board's standard on total loss-absorbing capacity (TLAC) requires capital and eligible debt of at least 18% of risk-weighted assets and 6.75% of the leverage exposure measure, levels that have applied in full since 2022. The European Union applies a bank-specific minimum requirement for own funds and eligible liabilities (MREL) to all banks, set by the resolution authority according to how each bank would be resolved.
To count towards these requirements, debt must generally be unsecured, have at least one year left to maturity, be subordinated to operational liabilities and be free of features such as derivatives that make it hard to value. Debt governed by the law of a country outside the home jurisdiction must contain a clause in which the holder recognises the bail-in power.
How a bail-in is applied
When a bank is judged to be failing, with no private solution available and resolution in the public interest, the bank resolution authority takes control. An independent valuation estimates the losses and the capital needed. Shares are cancelled or heavily diluted, capital instruments are written down, and bail-inable debt is then written down or converted into new shares to the extent required, usually over a weekend. Creditors are protected by the principle that none should be left worse off than in a normal insolvency, with compensation if they are.
European Union rules also require that shareholders and creditors absorb losses equal to at least 8% of the bank's total liabilities and own funds before the resolution fund can be used. The preparation for these steps forms part of resolution planning.
Implications for investors
Because holders can lose principal without a formal default, bail-inable debt carries lower credit ratings and higher yields than excluded liabilities of the same bank. Pricing depends on the bank's capital position and on how much junior debt sits beneath a given instrument. Many jurisdictions restrict sales of these instruments to retail customers, after cases in which small savers lost money on bank bonds they had not understood.
Critics question whether authorities would in fact bail in senior creditors of a very large bank during a system-wide crisis, when doing so could spread systemic risk to other institutions. The resolutions and rescues of 2023 showed both outcomes: some creditors were written down, while public support was still used elsewhere.