Bail-out has been a very common term in the financial terminology that most of us are aware of and has been a great escape route during the Global Financial Crisis. But, these days, a new term is taking over the Global financial market with a lot of pace. The term is ‘Bail-in’. The name has emerged as the alternative to bail-out and is taking over the market like a whirlwind.
The first question that runs through most of our minds is ‘What is this much talked about Bail-in?’ Answering it in the short, straight and easy language, one can say that Bail-in is the opposite of the legendary Bail-out. Going by the definition of the term Bail-in it can be said that the term refers to rescuing a financial institution that is on the verge of break-down. This is done by making the creditors and depositors of the institution bear the loss on their holdings. Cyprus gave the term to the world and had been in discussion since last six years now.
Why is Bail-in needed?
Ron Paul, the American Republican Congressman, has answered the question long before it even arose. He has said that when the bailout of a failing company is done, the money is being confiscated from the productive members of the economy and is given to the ones who are failing miserably. By assisting the companies that have antiquated work model, the government is interfering with the economic phenomenon. He said that an essential element of a healthy and thriving economy is that both the success and the failure must be allowed to happen as they are earned. By bailing out incompetent institutions, the government is preventing the liquidity of their resources and their availability to the companies that can put them to better and more productive use. The bailout is reversing the rewards by giving the proceeds of the successful ones to the ones who are failing miserably. This makes the bailout unhealthy for the economy. That’s how the Bail-in has become vital. Bail-in will prevent the moral hazard of the failing companies thinking that they can afford to make such losses.
What lies ahead for Bail-in?
The Cyprus Banking Crisis has led to the belief that the use of the Bail-in strategy would be extensive. It will be mostly because it will evade the difficult political issues associated with the bailouts of the taxpayers, while it will still contain the risk that is related to letting bank failures lead to the systematic failure destabilization.
There is a risk of Bond Markets reacting negatively. The increasing popularity of Bail-in can increase the risks for the Bondholders. This, in turn, will lead to the increase in the demand for the return they receive from lending money to these institutions. This can further lead to a rise in the interest rate that will in return hurt the Equities. All of this will end up in costing more in the long run than in a one-time recapitalization because the Future Capital will get much more expensive.
Cyprus has set a criterion and now the countries have an idea about what results it will fetch. It is very likely that the Bail-in and the Bail-out will see a combined future together.
Neither the Bail-out nor the Bail-in has been a choice. They both have arisen out of the necessity. It’s just that the Bail-in does not let the taxpayers pay for the mistakes of the big financial institutions, one thing that has been resented since the big financial crisis. As the Bail-in is spreading its wings, it will be interesting to see how it makes its space in the Bail-out ruled system with its pros and cons.