Bail-in 101

The bail-in regime is one of various measures the G20 member countries and the Financial Stability Board put in place after the near-collapse of the banking system following the 2008 financial crisis.

The bail-in regime provides a government with the so-called “bail-in power” to write down or convert certain liabilities of a bank into common equity for recapitalization when the government believes that the bank is likely to become non-viable going forward.

That power can be used at a government’s own discretion, and it’s the exact opposite concept to a bailout, since the burden is now borne by the investors who lend money to the bank, not taxpayers.

Not all securities issued by a bank are bail-inable.

Long-term senior unsecured debt (that is tradable and transferable with an original term to maturity of 400 days or more) and capital securities (including subordinated debt and preferred shares) are subject to the government’s bail-in power.

Deposits (including chequing accounts, savings accounts and guaranteed investment securities or GICs), short-term senior unsecured debt, secured debt (including covered bonds and asset-backed securities), structured notes and derivatives are not subject to the government’s bail-in power.

In Canada, the bail-in regime became effective in September 2018 and debt issued prior to this is grandfathered.

What does all this actually mean to an investor?

Let’s say you have $20,000 savings in an RBC chequing or savings account. You also own a $300,000 10-year senior unsecured note issued by RBC in October 2017 and a $100,000 5-year senior unsecured note issued by RBC in October 2018 as your investment holdings.

If the government were to view RBC as a non-viable bank and exercise its bail-in power, your $100,000 5-year senior unsecured notes would be converted into RBC’s common shares, whether or not you like that conversion.

On the contrary, the $20,000 will remain as deposits as this is exempt from bail-in. Your $300,000 will also remain as a senior unsecured note because it is grandfathered given that it was issued prior to September 2018.

The implementation of the bail-in regime, including grandfathering rules, differs moderately from country to country, but the overarching objective is consistent. It aims to prevent the government from providing implicit and explicit financial support to failing banks at the expense of taxpayers.

The bail-in power is, however, expected to be exercised in a way that respects the creditor hierarchy.

Therefore, in principle, senior bail-in debt holders should be better off than investors who hold subordinated debt and preferred shares if the bail-in conversion were to be triggered.

2 years ago