Building a More Resilient Financial Sector: Reforms in the Wake of the Global Crisis by Aditya Narain inci Ötker-Robe & Ceyla Pazarbasioglu

Author:Aditya Narain, inci Ötker-Robe & Ceyla Pazarbasioglu
Language: eng
Format: epub
ISBN: 9781475569360
Publisher: International Monetary Fund
Published: 2012-08-15T00:00:00+00:00

Effective Burden Sharing With the Private Sector

The use of “bail-inable” debt or “bail-in statutory powers” could play an important role in enhancing market discipline as part of an orderly resolution. The idea behind these instruments is to provide additional loss-absorbing capacity by converting private debt into equity capital when a bank comes under severe stress. Ensuring that private creditors provide loss-absorbing capital will boost market discipline and reduce the likelihood that taxpayer funds will be needed. The bail-in power (Box 7.1), a statutory approach to debt write-down or debt-to-equity conversion, deals directly with the resolution of SIFIs and may provide resolution authorities with an additional resolution tool to restructure bank debt.

Box 7.1 “Bail-In”: Debt Proposals

Proposals for bail-in debt, as well as for contingent capital, are under consideration as a potential market-based tool to address moral hazard risks associated with SIFIs. Regulators in several countries (Canada, the United States, and others in Europe) have shown interest in adding bail-in instruments to their crisis management toolkits. The concept, the scope, and the precise role of bail-in are currently under discussion within the Basel Committee, FSB, and EU.* An objective is to incentivize institutions to raise capital or to restructure debt voluntarily before a triggering of the bail-in power.

In general, the bail-in proposals are expected to provide a statutory approach to debt write-downs and debt-equity conversion, providing authorities with a new power to add to the capital base of a failing institution. By virtue of regulatory intervention while a distressed institution is operating under official administration (i.e., conservatorship), supervisors can hold off from declaring the institution insolvent and possibly avoid placing the institution into liquidation. The bail-in proposals would preserve the traditional priority of claims present in a formal liquidation (i.e., equity holders would absorb the first loss, followed by subordinated debt holders, followed by unsecured debt holders) with the prospect that, according to this priority, debt holders would obtain an equity interest. The prospect of such conversion rules on debt may add to market discipline and thus may also help curb excessive risk taking.

For bail-in to be an effective resolution tool, it must be designed to overcome legal challenges and difficulties in cross-border implementation while mitigating potential systemic risks. The legal framework for statutory bail-in must be carefully elaborated to reduce legal uncertainty, because upon the occurrence of the trigger event, creditors would be forced to give up full legal claims in exchange for overall value maximization in order that business operations could continue normally. This could conflict with laws that guarantee property rights if applied retroactively or without explicit terms and conditions built into the investment that explicitly recognize the right of authorities to carry out debt write-off or conversion into equity at the point of nonviability. The effectiveness of statutory bail-in also will depend crucially on its recognition within all relevant jurisdictions. Coordination at an international level is important to preserve a level playing field and avoid unintended consequences for the functioning of bank debt markets. Deposits, secured claims, and qualified financial contracts should, in principle, be excluded from the scope of bail-in debt.

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