A bail-in is the resolution system during banking crises. It is a tool that allows the authorities, when the conditions apply, to reduce the value of shares and certain credits or the possibility of conversion into shares in order to absorb losses and recapitalize the bank. In this way, adequate capitalization can be restored and market confidence maintained.
Shareholders and creditors will, under no circumstances, suffer greater losses than they would if the bank were liquidated under normal procedures.
The bail-in therefore allows the bank to continue to operate and offer the financial services deemed essential for the community and, since the financial resources for stabilization come from shareholders or creditors, this does not entail costs for taxpayers.
When does bail-in occur?
In the event of a credit institution crisis, the new legislation gives the Bank of Italy the task of deciding which measures to take.
There are 3 possibilities:
The resolution process is initiated only if deemed necessary for the public interest, i.e., when failure cannot be avoided by private measures (such as capital increases) and in cases where an ordinary liquidation would jeopardize the continuity of the bank’s functions, financial stability and the situation of depositors and customers.
If these conditions arise, the Bank of Italy can:
What does bail-in imply?
If zeroing out capital is not enough to cover losses and the liquidation route is not to be considered, the bank opts for a bail-in. Implementing a bail-in means either devaluing shares and credits and converting them into shares with the aim of absorbing losses and recapitalizing the bank that is struggling or a new entity to carry on its essential functions.
Public intervention is only envisaged in extraordinary circumstances to avoid serious repercussions on the financial system.
Which liabilities are excluded from a bail-in?
Besides the hierarchical order of who is expected to bear the burden of rescuing the bank, the bail-in foresees that no shareholder or creditor should bear losses greater than those they would suffer from a compulsory liquidation (No Creditor Worse Off principle).
Moreover, protected deposits do not suffer losses: deposits of up to EUR 100,000 are excluded from the bail-in. Secured liabilities and interbank liabilities with an ordinary maturity of less than 7 days cannot be subject to bail-in either. The Bank of Italy may also exclude other liabilities, provided that the bail-in is equal to at least 8 per cent of the total liabilities. The National Resolution Fund, fed by bank contributions, may cover the relevant capital needs up to a limit of 5 per cent of total liabilities.
What do savers risk in the event of a bail-in?
The bail-in is applied following a hierarchy whose logic is that those who have invested in riskier financial instruments will suffer losses or conversion into shares before other investors. The next category will only be affected after having exhausted all the resources of the riskiest category.
Firstly, the interests of the bank’s “owners”, i.e., the existing shareholders, are sacrificed by reducing or zeroing the value of their shares. Secondly, certain categories of creditors are affected, whose assets can be transformed into shares – in order to recapitalize the bank – and/or reduced in value, if the reduction of the value of the shares is not sufficient to target the losses.
Through the bail-in, the costs of a possible banking crisis will be prioritized as follows:
What risks do depositors incur in a bail-in?
Deposits of up to EUR 100,000, i.e., those protected by the Deposit Guarantee Fund, are expressly excluded from bail-in. This protection concerns, for example, sums held on current accounts or in a savings account and deposit certificates covered by the Guarantee Fund. It does not concern other forms of savings such as bank bonds.
The portion in excess of EUR 100,000 for deposits that refer to natural persons and small and medium-sized enterprises receive preferential treatment. They would only be affected if the bail-in of all instruments with a lower degree of protection in the bankruptcy hierarchy is not sufficient to cover losses and restore an adequate level of capital.
Retail deposits in excess of EUR 100,000 may also be excluded from bail-in on a discretionary basis in order to avoid the risk of contagion and preserve financial stability provided that bail-in has been applied to at least 8 per cent of total liabilities.
How can the bank’s soundness be assessed?
A client can assess the bank’s soundness by checking an indicator called the CET 1 ratio. The CET 1 (Common Equity Tier 1) ratio is the index that measures the soundness of a bank. It is obtained by calculating the ratio between the bank’s available capital and its market assets (e.g., loans granted, bonds…).