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Why Bail-In Securities Are Fool's Gold

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  • Avinash Persaud

    (Peterson Institute for International Economics)

Abstract

Bail-ins and creditor haircuts have long been a feature of resolutions and recapitalizations when banks have become, or are on the verge of becoming, “gone” concerns. The public outcry against taxpayer bailouts has led to the development of something new—the automatic bail-in of creditors of institutions that are still “going concerns.” Bail-in securities, commonly known as cocos (contingent, convertible capital instruments), convert into equity once a bank's capital falls below a preannounced level. Even before the ink is dry on regulators' proposals, banks have started to issue cocos and the market has quickly grown to a capitalization of $150 billion. Bail-in securities may make sense for an idiosyncratic bank failure. But they do not make sense in the more common and intractable case where many banks get into trouble at roughly the same time as the assets they own go bad. On such occasions these securities, which may also have encouraged excessive lending, either will inappropriately shift the burden of bank resolution on to ordinary pensioners or, if held by others, will bring forward and spread a crisis. If more gold plating of bank capital is what is required, then this fool's gold will not do.

Suggested Citation

  • Avinash Persaud, 2014. "Why Bail-In Securities Are Fool's Gold," Policy Briefs PB14-23, Peterson Institute for International Economics.
    • Handle: RePEc:iie:pbrief:pb14-23
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    File URL: https://www.piie.com/publications/policy-briefs/why-bail-securities-are-fools-gold
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    Cited by:

    1. Avinash D. Persaud, 2015. "How Not to Regulate Insurance Markets: The Risks and Dangers of Solvency II," Policy Briefs PB15-5, Peterson Institute for International Economics.
    2. Pietro Alessandrini & Michele Fratianni & Luca Papi & Alberto Zazzaro, 2016. "The asymmetric burden of regulation: will local banks survive?," Mo.Fi.R. Working Papers 125, Money and Finance Research group (Mo.Fi.R.) - Univ. Politecnica Marche - Dept. Economic and Social Sciences.
    3. Gaëtan Le Quang, 2019. "Mind the Conversion Risk: a Theoretical Assessment of Contingent Convertible Bonds," Working Papers hal-04141886, HAL.
    4. Philippe Oster, 2020. "Contingent Convertible bond literature review: making everything and nothing possible?," Journal of Banking Regulation, Palgrave Macmillan, vol. 21(4), pages 343-381, December.
    5. William R. Cline, 2016. "Benefits and Costs of Higher Capital Requirements for Banks," Working Paper Series WP16-6, Peterson Institute for International Economics.
    6. Gaëtan Le Quang, 2019. "Mind the Conversion Risk: a Theoretical Assessment of Contingent Convertible Bonds," EconomiX Working Papers 2019-5, University of Paris Nanterre, EconomiX.
    7. Durand, Pierre & Le Quang, Gaëtan, 2022. "Banks to basics! Why banking regulation should focus on equity," European Journal of Operational Research, Elsevier, vol. 301(1), pages 349-372.
    8. Farmer, J. Doyne & Goodhart, C. A. E. & Kleinnijenhuis, Alissa M., 2021. "Systemic implications of the bail-in design," LSE Research Online Documents on Economics 111903, London School of Economics and Political Science, LSE Library.
    9. Claudia Pigrum & Thomas Reininger & Caroline Stern, 2016. "Bail-in: who invests in noncovered debt securities issued by euro area banks?," Financial Stability Report, Oesterreichische Nationalbank (Austrian Central Bank), issue 32, pages 101-119.
    10. Micossi, Stefano & Bruzzone, Ginevra & Cassella, Miriam, 2016. "Fine-tuning the use of bail-in to promote a stronger EU financial system," CEPS Papers 11505, Centre for European Policy Studies.

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