The bail-in tool at banks

The aim of a bail-in is to recapitalise a bank and restore compliance with the capital requirements. The recapitalisation is achieved by imposing losses on bondholders. Their bonds are converted into equity during the bail-in. At UBS, for example, FINMA’s resolution strategy involves converting the bail-in bonds issued by the group holding companies into equity. Bondholders of other entities in the group, in particular the parent company and its subsidiaries, are unaffected. 

Debt instruments replaced by new shares

FINMA may order a bail-in as part of a resolution procedure. Before a bail-in takes place, the bank’s entire equity capital is written down. This means that the previous shareholders cease to be owners of the bank. Thereafter, creditors’ claims are converted into equity, which creates new shares. For example, if a bondholder has bought a debt instrument issued by the bank, a bail-in means they will forfeit their right to repayment of the agreed principal at the end of the instrument’s term. In return for this loss, the bondholder receives an equivalent value of newly created shares and thus an ownership stake in the restructured bank.

Bail-ins are governed by clear rules, particularly on the hierarchy according to which creditors’ claims are converted into equity. First the equity capital is written down, then subordinated claims are converted, then the other senior debt and only after that the non-preferred deposits (i.e. deposits over CHF 100,000). Privileged claims – particularly deposits of up to CHF 100,000 – as well as secured claims and claims eligible for netting are excluded from a bail-in.

The bail-in process

After intensive preparations, a bail-in begins with an ad hoc announcement by the bank before the start of trading on the stock market and notification of the holders of the relevant debt instruments. The exchanges on which the shares of the bank are traded will suspend trading in the shares due to be written down in the bail-in and the debt instruments subject to conversion. The shares newly created by the bail-in will be registered. Trading in these new shares is expected to begin at the earliest three days after completion of the bail-in. The new shareholders’ voting rights may be restricted in the first few months after the bail-in to ensure that the restructuring measures can be implemented.

The no creditor worse off principle

A resolution, and in particular a bail-in, can encroach on the rights of creditors to a significant degree. To maintain proportionality, resolutions must comply with the internationally recognised “no creditor worse off” (NCWO) principle. This means that a resolution may only be carried out in Switzerland if all creditors are in a better position than they would be if the bank had been liquidated immediately. To ensure this, FINMA must carry out an evaluation before approving the restructuring plan. For instance if it wants to implement a bail-in, it must estimate the value of the newly created shares the creditors will receive and set this against the hypothetical bankruptcy dividend. If the first estimate exceeds the second, the restructuring plan can be approved.

Of course, these estimates necessarily involve assumptions and forecasts and are thus uncertain. FINMA makes the best possible estimate with the information available at the time.