Understanding a Bail-In
A bail-in is a financial mechanism used to rescue a failing financial institution by nullifying debts owed to creditors and depositors.
When a financial institution is on the verge of collapse, the investors, shareholders, and deposit holders may choose a bail-in instead of losing their entire investment or deposit in a catastrophic event.
Similarly, the government is interested in preventing an institution’s collapse, as a large-scale bankruptcy can lead to systemic economic issues.
Understanding Bail-Ins
Bail-ins have gained support from many stakeholders due to their ease of implementation.
Europe has employed bail-ins to address significant challenges, and the Bank of International Settlement (BIS) has openly discussed their use to incorporate them into the European Union.
Bail-ins are primarily used for the following reasons:
- An institution on the brink of failure can use a bail-in to cancel debts owed to clients or customers.
- The institution or government lacks the funds required for a bailout.
- A bail-in is needed to reduce the burden on taxpayers’ savings.
Bail-Outs vs. Bail-Ins
A bail-out occurs when an external investor, such as the government, provides financial support to a failing institution.
Bailouts expose taxpayers to risk, while bail-ins distribute the risk among creditors, helping to maintain low-interest rates and keep creditors satisfied.
Bail-ins are typically employed when liquidation is not a viable option for creditors or when implementing a bailout is politically challenging.
Preventing a Bank Bail-In
Several steps can be taken to prevent a bank bail-in.
Stakeholders should closely monitor the market and assess the financial stability of any institution they intend to do business with.