5 Bail-In Bonds

In the banking crisis that hit Cyprus early 2013, bail-in bonds were part of the solution. The concept of bail-in capital is different from the contingent convertible capital discussed in Chapter 3. In the case of bail-in, a national resolution authority will force the write-down of a specific category of debt while respecting its seniority on the balance sheet.

5.1 INTRODUCTION

The collapse of a SIFI will rock the financial markets. Similar to the Lehman collapse, its failure will be widely felt by other financial institutions. Some banks may have direct counterparty exposure to a failed institution because of outstanding uncollateralized derivative transactions. Even banks with little or no direct exposure to a failed bank will feel the heat. Creditors of such a collapsed bank may be forced to sell their assets in order to raise cash. This liquidation exercise is a real problem if the assets are not liquid. The case of Lehman Brothers shows how this ultimately led to a wave of disorderly selling, where the actions of one bank inflict losses on another bank. The financial stability of the economy as a whole was in danger again, since even banks with no direct link at all to a failed SIFI – nor holding any assets on its balance sheet similar to the ones held by the failed bank – suffer. Panic spreads throughout the whole financial market and every bank sees its funding costs increase.

In a bail-in solution the unsecured creditors of a bank provide the additional ...

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