Bail-in of creditors to rescue a bank

One measure that can aid the resolution of a financial institution in difficulty is known as a bail-in. This gives FINMA the power to write down the claims of a failing institution’s non-protected creditors and convert debt claims into equity.
When a systemically important Swiss bank encounters financial difficulties, the first steps taken are aimed at recovery. It may, for example, decide not to pay a dividend or sell off some of its businesses. The bail-in comes into play if these measures prove insufficient. It entails FINMA ordering the compulsory conversion of debt into equity or a reduction in claims at the highest level of the group.

Creditors must participate in the rescue

The term «bail-in» means that an institution’s creditors participate in the solution to its financial problems. It contrasts with a bail-out, the cost of which is borne by the government and thus ultimately by taxpayers. Bondholders’ participation in the rescue of a bank represents a genuine paradigm shift and is the key to making the implicit state guarantee a thing of the past.

The idea is that creditors should bear the institution’s losses, as they do in bankruptcy. The bail-in takes effect when the bank’s survival is no longer guaranteed – at the very latest when its equity ratio falls below 5%. In principle, all debt claims against banks – with few exceptions – are subject to compulsory conversion into equity or compulsory reduction. In the case of conversion, the hierarchy of creditors must be observed, and no category of creditors must end up receiving less than they would in the event of bankruptcy. The bail-in does not include secured, privileged and offsettable claims. Privileged bank deposits up to CHF 100,000 are thus not affected by the bail-in.

CoCo bonds

Contingent convertible (CoCo) bonds are a form of bail-in developed in Switzerland to address the «too big to fail» problem. They entail a contractual agreement between the debtor and the creditor regarding how claims are written off or converted into equity in a crisis, turning lenders into shareholders with the attendant liability.