Last Tuesday, the International Monetary Fund (IMF) released a research paper advising policymakers to consider creating bail-in rules to deal with distressed systemically important financial institutions (SIFIs). Moody’s says the IMF’s support for cross-border bail-ins is credit negative for bondholders of SIFIs because, if implemented, a practical bail-in mechanism increases the likelihood that bondholders will receive a haircut on the debt of banks close to insolvency.
However, implementation of a credible bail-in framework for SIFIs faces significant challenges because they generally operate through a number of legal entities in different jurisdictions. We consider it unlikely that all regulators would recognise the bail-in powers of foreign peers, especially when it involves imposing losses on local bank creditors to protect a foreign SIFI.
The creation of a bail-in framework will likely receive significant public support since it aims to reduce the systemic risk caused by a SIFI’s disorderly default and restore its capital without tapping taxpayer funds. Consequently, government support to an ailing bank may be limited to providing emergency liquidity to restore market confidence. The IMF’s research paper follows a European Commission (EC) proposal outlining several options to implement a viable bail-in framework. Currently, most countries lack a detailed bail-in framework for senior unsecured bondholders, although some, including the UK, Denmark and Ireland, have legislation in place that allows bailing-in certain liabilities.