Using sectoral T-accounts, this paper analyzes the implications of bank bail-outs and bank bail-ins. Contrary to popular opinion, bank bail-outs do not utilize taxpayers’ money. Moreover, bank bail-outs funded through recapitalization bonds or deficit financing and bail-ins have similar net effects on sectoral balance sheets. There are, however, questions of moral hazard and normative issues of fairness that must not be ignored.
The global financial crisis (2008) led to a collapse of many banks and financial institutions, plunging their net worth into negative territory. To restore their balance sheets and provide capital to meet adequacy norms, it was proposed that governments support bail-out packages. However, in mainstream economics discourse, it was argued that this implied “using taxpayers’ money”.
Consider for example, these headlines:
British taxpayers face 27 billion pound loss from bank bailout (MacAskill and White, 2016)
Taxpayers are still bailing out Wall Street, eight years later (Merle, 2016)
The likely political consequences of this popular understanding of bank bailouts are clearly evidenced in a statement by former U.S. President, Barack Obama:
“So I know how unpopular it is to be seen as helping banks right now, especially when everyone is suffering in part from their
bad decisions. I promise you – I get it.” (Hecht,2009).
With bank bail-outs becoming increasingly unpopular, the alternative of bank bail-ins emerged. In case of bank bail-ins, depositors’ money would be used to set off the loss accruing to banks from write-off of NPAs; in other words, the cost of bank failures is redistributed from taxpayers to banks’ creditors. This seems to have found favour with governments. The first bank bail-in was implemented in Cyprus in 2013; however, the implications of the program were largely negative with a significant flight to cash and a low level of future confidence in banks, especially those that incurred a deposit and/or bond bail-in (Brown et al., 2018).
In spite of the criticisms levelled against bank bail-ins, we find its acceptance across the world. In 2015, the European Commission issued the Bank Recovery and Resolution Directive (BRRD) to 11 EU countries to rescue banks by implementing the bail-in process. More recently, bank bail-in rules have already been established or are in the process of being legislated in Canada, USA, Turkey and India.