Bail-ins win further support

Panellists at a London School of Economics conference on Monday added their backing to the idea of bail-in capital.

David Wright, the director of financial markets policy at the directorate general for internal markets, said at the conference: "If you do not have some instrument with which supervisors can intervene early then you're driven into the US system, where you drive firms into bankruptcy. There's a great interest in having bail-ins in the toolbox."

The idea behind bail-in capital is that debt will be converted into equity at a time when a bank is on the brink of failure in order to recapitalise the teetering institution. Paul Tucker, a deputy governor at the Bank of England, and Stefan Ingves, the governor of the Riksbank, last month backed the idea.

The idea resembles that for contingent capital, or CoCos: debt instruments that automatically convert to equity when a pre-determined floor of individual or industry-wide losses is breached. However, unlike CoCos, the trigger for the conversion of which must be set out beforehand, bail-ins will involve regulators' discretion. Wright said: "There's an argument that we can't allow capricious regulators to make difficult decisions. Well frankly, that's what they're paid for."

Wilson Ervin, a senior adviser to the chief executive of Credit Suisse, a bank, noted that it would often be in markets' interest to back such a fix. "If you take the example of Lehman Brothers, if they'd done a bail in over the weekend before failure investors would have had to write down $25 billion. Liquidation cost $150 billion," Ervin said. "It would have produced the best capitalised bank in the United States, it would've been open for business on the Monday morning, and the system would've been under much less stress."

However, Charles Goodhart, a professor at the London School of Economics and a former member of the Bank of England's Monetary Policy Committee, warned triggering a bail-in could leave other banks in trouble. "Debt rolls over and so all banks have to go back to capital markets on a regular basis. What would a bail-in do for the workings of the capital market?"

Christian Lajoie, the co-head of group financial regulation and public affairs at BNP Paribas, a bank, agreed that this was a potential concern. "I always believe markets need certainty, and this is why I defer somewhat on the question of bail-ins. I would restrict a bail-in to subordinated debt. Otherwise you introduce a lot of legal uncertainty."

However, Wright noted that though this problem might exist at present, by educating investors, regulators could create an environment in which creditors would better understand when and why banks would be bailed in. "Would a bail-in result in a dangerous ripple effect? Today it might well do. But we're not talking about today. We're talking about once the market understands the difference between failing institutions and others. It's not beyond the will of man, or even capital markets to understand this."