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We are now entering bail-in territory for banks. In central bankers’ parlance, failing banks will be restructured by “bailing in” the investors, instead of being bailed out with taxpayers’ cash.
In plain English, debt investors in banks (as well as the shareholders) will lose their money when trouble strikes, something that has not happened before. The idea is deceptively simple and compelling. The public purse will not be called upon again. But where will the buck really stop when banks get into trouble in the future?
Investors are all learning the new language of “bank resolution”, as restructuring a bust bank is now known. Analysts are up late reading papers issued by the panoply of regulatory bodies, all promulgating a widening and imaginative array of proposals to deal with future problems more efficiently than in the past. All well and good, but although the outline of the regulatory framework has been clear for some time, the practical details remain elusive.
The mechanics of bail-in still appear unclear, mainly due to their practical complexity, although the Bank of England has gone further than most in setting out the actions and decisions that are required. Nevertheless, investors will remain in the dark over a number of key points, including where non-viability might occur and the basis of resolution valuation when calculating any bail-in.
On one point, however, most are now clear. If a bank fails, a bank’s debt and equity will be written off, or at least written down substantially, imposing immediate tangible losses on the holders of the securities. These will mainly be private sector investors, such as pension funds, insurers and mutual funds, many of which are looking after the money of ordinary savers, albeit at arm’s length.
Adding to the calculations around bail-in are proposals from the Financial Stability Board requiring banks to hold significant cushions of loss-absorbing debt. Known by the acronym of TLAC (total loss absorbency capacity), the proposals set out the need for a minimum cushion of debt that can easily be written off. The TLAC in some shape is now set to be a fixed feature of the overall framework of banking regulations.
The theory goes that there is a hierarchy of creditors — a queue of investors awaiting their fate — where the equity is written off first, followed in order by subordinated and senior debt. In practice, legacy terms of old issues, the prior ranking of a whole line of other creditors (including most depositors, central banks providing liquidity and secured lenders) causes a whole lot of queue jumping.