DP10065 A Critical Evaluation of Bail-in as a Bank Recapitalisation Mechanism

Author(s): Emilios Avgouleas, Charles A E Goodhart
Publication Date: July 2014
Keyword(s): bail-in, bank recapitalisation, bank regulation, creditor flight, moral hazard
JEL(s): G18, G28, K20, L51
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10065

Many of the world?s developed economies have introduced, or are planning to introduce, bank bail-in regimes. Both the planned EU resolution regime and the European Stability Mechanism Treaty involve the participation of bank creditors in bearing the costs of bank recapitalization via the bail-in process as one of the (main) mechanisms for restoring a failing bank to health. There is a long list of actual or hypothetical advantages attached to bail-in centred bank recapitalizations. Most importantly the bail-in tool involves replacing the implicit public guarantee, on which fractional reserve banking has operated, with a system of private penalties. The bail-in tool may, indeed, be much superior in the case of idiosyncratic failure. Nonetheless, there is need for a closer examination of the bail-in process, if it is to become a successful substitute to the unpopular bailout approach. This paper discusses some of its key potential shortcomings. It explains why bail-in regimes will fail to eradicate the need for an injection of public funds where there is a threat of systemic collapse, because a number of banks have simultaneously entered into difficulties, or in the event of the failure of a large complex cross-border bank, except in those cases where failure was clearly idiosyncratic.