“Bail-In’s” Are Not To Be Feared – Your Decisions Are

This past week, I read an article written by Mark O’Byrne which suggested that investors should fear the “bail-in.” Unfortunately, most do not really understand what happens during a “bail-in” scenario, so the fear regarding it seems to trump the benefits.

 

So, while many believe that they can simply walk into the bank and demand their money at any point in time, this is simply not the case. If the bank should run into financial difficulties and default, you will stand in line with the rest of the bank creditors to receive pennies on the dollar through the bankruptcy process.

Many of you are now saying to yourselves that this is not such a big issue to most American’s since the FDIC guarantees bank deposits up to $250,000 per depositor, per insured bank. So, of course, most Americans believe that their bank deposits are quite secure, since the FDIC is backstopping their unsecured status. While this belief is reasonable when individual banks run into problems due to extenuating circumstances which may cause relatively small defaults across the system, it is not a reasonable belief during times of systemic stress.

Consider that in 2009, as we were experiencing a tremendous amount of stress on the banking system as a whole, the FDIC Insurance Fund fell into a deficit of almost $21 billion. Yes, you read that right. The supposed “backstop” had a massive deficit. So, one has to consider how much you can rely upon the FDIC if we should see an even worse systemic break down than the one seen in 2008.

What Is A “Bail-in?”

In order to understand what a “bail-in” is, we need to go back several years to understand what happened in Cyprus.

When the financial crisis hit the Cypriot banks several years ago, which were already in a poor fiscal position after the conversion to the Euro, there was no bail out being offered by the government or the European Union (much of the reasons for which seem to have been political in nature). As a result, two of the largest banks were on the verge of closing. Ultimately, Laiki Bank had to be wound down, and the depositors of that bank lost most of their uninsured savings. However, the Bank of Cyprus, rather than wind down as well, entered into a restructuring, and utilized the cash held from depositors for the funds needed to effectuate the restructuring. The depositors were issued shares in the newly restructured bank in return for their deposits which were used for the restructuring.

So, ultimately, a “bail-in” is a restructuring of the bank, which uses depositor funds to effectuate the restructuring. The question then is if this is good or bad for those who have deposits in the particular bank at issue.

Is A “Bail-in” Bad?

Should a bank encounter insolvency, I would suggest that a depositor would be better served by bail-ins as compared to the bankruptcy option the bank would face. As a former lawyer with a significant amount of mergers and acquisitions experience, I would argue that the depositors may prefer a “bail-in” in such a scenario.

Under such extreme circumstances, a “bail-in” at least preserves the “good” assets of the bank, and gives them future hope of being able to recover more of their losses than they would have otherwise had to recognize under the bankruptcy option. The bankruptcy alternative truly leaves them nothing in their unsecured status, so providing a restructuring using a “bail-in” type of scenario places them in a better position than as a standard unsecured creditor would hold.

So, ultimately, it is not the “bail-in” which must be feared. Rather, your decision making about which bank you choose to hold your deposits is much more important. You see, you can potentially avoid a “bail-in” if you do appropriate due diligence on the bank of your choice. If you choose a bank which is not heavily leveraged, then you will likely never encounter any insolvency issues that would lead to a “bail-in.” But, if you do not choose wisely and find your deposits being held by a bank facing insolvency, then the bail-in scenario would place you in a much better position than if the bank went down the bankruptcy route.

So, choose wisely.

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