Bail-in is the opposite of a bail-out because it does not rely on external parties, especially government capital support. It creates new capital to rescue a failing firm through an internal recapitalization and forces the borrower’s creditors to bear the burden by having part of the debt they are owed written off or converted into equity.
Thus, Bail-in provides relief to a financial institution on the brink of failure by requiring the cancellation of debts owed to creditors and depositors. It is the opposite of a bailout, which involves the rescue of a financial institution by external parties, typically governments, using taxpayers’ money for funding. Bailouts help to keep creditors from losses while bail-ins mandate creditors to take losses.
What Did Bail-in and Bailout?
- A bail-in provides relief to a financial institution on the brink of failure by requiring the cancellation of debts owed to creditors and depositors.
- Bail-ins and bailouts are both resolution schemes used in distressed situations.
- Bailouts help to keep creditors from losses while bail-ins mandate creditors take losses.
- Bail-in schemes are being more broadly considered across the globe as a first phase resolution to help mitigate the number of taxpayers’ funds used in supporting distressed entities.
The bail-in was first proposed publicly in an Economist Op-Ed “From Bail-out to Bail-in” in January 2010, by Paul Calello and Wilson Ervin. It was described as a new alternative between “taxpayer bail-outs and systemic financial collapse.” It envisioned a high-speed recapitalization financed by “bailing-in” bondholder debt into fresh equity. The new capital would absorb losses and provide new capital to support critical activities, thereby avoiding a sudden disorderly collapse or fire sale, as seen in the Lehman failure.