Bail-in
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Regulatory Capital Anatomy™
The JC’s untutored thoughts on how bank capital works.
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bail-in
(n.)
A regulatory mechanism that applies to regulated financial institutions as they teeter on the edge of oblivion. It allows a prudential regulator to write down, cancel or convert into common equity any part of the institution’s indebtedness. This is designed to protect retail depositors and preserve essential systemic stability by sacrificing a small class of investors while saving everyone else.
This is quite a big deal, seeing as senior, unsecured indebtedness is meant to be senior in the hierarchy of investors and stakeholders in a company.
Some types of debt instruments — for example, alternative tier one capital — are explicitly designed to have this happen, and pay a whopping interest coupon to compensate for this contingency.
For others, like senior unsecured bonds, loans and so on, it is less obvious. So much so that bank resolution legislation requires, on pain of — well it isn’t really clear on pain of what, exactly — legal departments to go around inserting approved contractual bail-in language into some contracts warning their participants that a bail-in event might happen.
This we think runs against the general grain of how laws work: it is tough luck if you get bailed in: citizens should know the laws of the land and it shouldn’t be incumbent on contractual counterparties to advise each other of them — and in any case, it is what it is: whether you know about a bail in or not, if one happens you will get caught up.
Assiduous legal eagles have gone around inserting bail-in language in all kinds of contracts for which it is not especially relevant.