The Case for Bail-ins
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1 The Case for Bail-ins Dr. Thomas F. Huertas Institute for Law and Finance Frankfurt 3 May 2012
2 The case for bail-ins: summary Too big to fail is too costly to continue Bail-ins are superior to bail-outs Bankruptcy doesn t work for banks Bail-ins may be superior to insolvency/liquidation Banks need a special resolution regime How Private Markets Have Solved Similar Problems How Bail-in Could Work For groups organized as holding companies For unitary banks Conclusions Page 1 03 May 2012 [Presentation title]
3 Too big to fail is too costly to continue bail-outs strain the public finances bail-outs distort competition bail-outs undermine market discipline bail-outs are not an option Page 2 03 May 2012 [Presentation title]
4 Bankruptcy doesn t work for banks banks cannot operate whilst in insolvency liquidation destroys value and diminishes the recovery that creditors can make for systemic banks liquidation would have large adverse knock-on effects on financial markets and the economy at large Page 3 03 May 2012 [Presentation title]
5 Banks need a special resolution regime To avoid bail-outs and to avoid liquidation banks need a special resolution regime. This empowers the resolution authority to intervene at the point where the bank no longer meets threshold conditions and to employ the tools in its resolution tool kit to resolve the bank in a manner that Does not require taxpayer support for the bank s solvency; and Does not result in significant social costs (disruption to financial markets, reductions in output and employment) The first question is whether bail-ins should be in the tool kit at all. If so, when should the resolution authority utilise the tool? Page 4 03 May 2012 [Presentation title]
6 What tests does bail-in need to meet? bail-in must be better than bail out bail-in must be better than insolvency/liquidation bail-in must be workable But bail-in need not be the only solution bail-in can be used in conjunction with other tools Page 5 03 May 2012 [Presentation title]
7 Banks have used bail-in to solve similar problems in private markets Securitization structures are designed to avoid bankruptcy. Securitization structures effectively bail-in junior creditors in reverse order of seniority as cash flows dry up. Securitization structures are designed to go into solvent winddown if asset and liquidity tests are not met. Cash flow from assets Super- Senior Senior Stub Equity Huertas Risk and Reward
8 What should a solution involving bail-ins deliver? continuity of critical economic functions This minimises social cost. This requires that the institution in resolution have access to adequate liquidity. Bail-in will not produce a Lazarus effect. no taxpayer support for solvency This eliminates drain on the public finances. sufficient certainty with respect to process that authorities will employ in resolution with respect to each element in the capital stack to enable investors to estimate loss given resolution This helps assure that the bank can issue the instruments that will be subject to bail-in Huertas Risk and Reward
9 How bail-in could work intervention Home-host cooperation is vital Resolution authority evaluates options Execute Bail-in Recovery Sale COB Friday Monday Asia open Deposit transfer/ Bridge bank Subsequent month
10 Bail-in via conversion at unitary bank Liability structure prior to intervention Deposits Other debt Liability structure after conversion Deposits Other debt Distribution of new common equity among old providers of investor capital Formerly senior obligations acquire predominant share in new equity Senior debt Subject to bail-in Tier 2 Non-core Tier 1 New Common equity Common Equity After Write down Common equity Old common equity suffers death by dilution
11 How bail-ins could work: holding companies and the single point of entry Global source of strength doctrine? Based on structural subordination of holding company debt Liquidity? Parent holding company Domestic bank Foreign subsidiaries Domestic subsidiaries Foreign subsidiaries Page May 2012 [Presentation title]
12 Conclusions bail-ins are superior to bail outs bail-ins are superior to liquidation bail-ins may be an effective resolution tool. They merit inclusion in the resolution tool kit under a special resolution regime. some key questions remain How to assure that there will be outstanding an amount of instruments subject to bail in sufficient to recapitalise the institution whilst assuring continuity of critical functions Treatment of foreign branches and subsidiaries/cooperation among authorities Provision of liquidity to institution in resolution How to restore the institution post bail-in to private investor control/exit from resolution/constraints on discretion of resolution authority Page May 2012 [Presentation title]
13 Thank you
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