What is 'Bail-In'?

A bail-in is the rescue of a financial institution that is on the brink of failure whereby creditors and depositors take a loss on their holdings. A bail-in is the opposite of a bailout, which involves the rescue of a financial institution by external parties, typically governments that use taxpayers money. Bailouts have been far more common than bail-ins. However, in recent years, and following massive bailouts, some governments now require the investors and depositors of a bank to take a loss before taxpayers.

 

BREAKING DOWN 'Bail-In'

 

Breaking Down Bail-Ins

Bail-ins and bailouts arise out of necessity rather than choice. Investors and deposit-holders in a troubled financial institution would prefer to keep the organization solvent rather than face the alternative of losing the full value of their investments or deposits if the bank fails. Governments also would prefer not to let a financial institution fail because a bankruptcy on this scale could increase the likelihood of systemic risk in the market (see the bankruptcy of Lehman Brothers in September 2008). 

Typically, a bail-in would occur in cases where a government bailout is unlikely because either (a) the financial institution's collapse is not likely to pose a systemic risk because it does not fall into the "too big to fail" category, or (b) the government does not possess the financial resources necessary for a bailout because it is itself heavily indebted. 

The Cyprus Experiment

While the general public became familiar with the subject of bailouts in the aftermath of the Great Recession of 2008, bail-ins attracted attention in 2013 after government officials resorted to the strategy in Cyprus. The consequences were that uninsured depositors (defined in the European Union as people with deposits larger than €100,000) in the Bank of Cyprus lost almost half of their deposits. In return, they depositors received bank stock. However, the value of these stocks did not equate most depositor's losses. Uninsured depositors in Laiki, the nation's second-largest bank, lost everything as the bank failed. According to Greek Reporter, the European Commission stated in November 2017 that the nation's growth is forecast to reach 3.5 percent of GDP and to ease but remain robust both in 2018 and 2019, which exceeded expectations..

Bail-Ins Before Bail-Outs

Both the European Union and the United States have restricted the use of government bailouts, which effectively makes bail-ins a default option for a bank in distress. The sentiment behind a bail-in is that taxpayers should not have to shoulder the cost of big banks' mistakes. During the financial crisis, governments paid trillions of dollars of taxpayer's of money to rescue the big banks while ordinary people also lost their jobs and homes.

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