4.3.4.6 Criticisms of the bail-in tool

In order to fully understand the bail-in tool and its implications, it is useful to briefly discuss the criticisms that the introduction of the bail-in tool has received. These criticisms concern the implications on the funding costs of banks and the risk of contagion.

The possibility of a bail-in might make it more difficult for banks to obtain funding. The consequence of a bail-in is that bank debt entails more risk for the debt-holders, so bank debt instruments become a less attractive investment. The implicit State guarantee was removed because of the bail-in tool.1 As a consequence, investors are only willing to invest in bank debt instruments if the bank compensates them for the higher risk; in other words, they will demand a higher rate of return. To conclude, the bail-in could lead to higher funding costs for banks.

The bail-in tool might create contagion.2 Banks are interrelated and interconnected. Debt instruments (that could be bailed in) are often held by other banks.3 A bail-in could thus be harmful to other banks and could thus have negative repercussions on financial stability.

The application of the bail-in tool could create social unrest. The rationale of the bail-in tool is presented as shifting the burden from taxpayers to investors. It should, however, be pointed out that ‘the taxpayer’ and ‘the investor’ can be the same person. Some households have invested in banks. Italy is a well-known example: Italian households hold about one-third of senior bank debt and almost half of total subordinated bank debt.4 Furthermore, households are sometimes indirect investors in banks, because pension funds and insurance companies invest in banks.5 Since households are the ultimate beneficiaries of pensions and insurance pay-outs, a bail-in of the claims of pension funds and insurance companies might indirectly harm these households.

In my opinion, while it is certainly true that a bail-in could be painful for investors, it should not be forgotten that a bailout is not completely painless for them either. Indeed, under the State aid control framework, burden-sharing by shareholders and by subordinated creditors is required.

For some creditors, the bail-in might be more burdensome than a bailout.6 A bailout may have been more favourable to them. However, it should be recalled that a bailout (i.e. State aid) is not a right; Member States are not obliged to grant aid.7 The counterfactual scenario is an insolvency of the bank. And the ‘no creditor worse off principle’ provides that the application of the bail-in tool might not result in a worse position of creditors than in case of an insolvency.