Why Bail-In? And How!
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Why Bail-In? And How!

Joseph H. Sommer
Federal Reserve Bank of New York, 2013
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Years after the global financial crisis, US regulators are still struggling to create a system of orderly insolvency for too-big-to-fail financial institutions. In this short article, Federal Reserve Bank of New York attorney Joseph H. Sommer advocates the process known as “bail-in” and explains why it would best suit these institutions in case they face failure. Certainly, a bit of Latinate lawyer-speak intrudes into the report, but most readers will find it much more readable and far less turgid than the math-muddled discourses of the economists who typically write on such issues. If fact, because of the author’s short sentences, simple writing style and witty asides, this work is arguably one of the more accessible accounts of the technical aspects of bail-in, bankruptcy and insolvency. getAbstract recommends this analysis for its clarity as well as its informative content to interested readers as well as to financial professionals and policy makers.

Summary

What Is a “Megabank”?

In contrast to typical banks, megabanks are bigger, more complicated, more leveraged, and more likely to interconnect globally with other financial institutions. In fact, these “large international financial conglomerates” don’t even have to be banks; they could be hedge funds or insurance companies. They carry liabilities – mostly financial products with varying degrees of liquidity – that differ from those of typical corporations. And because they are multinational, they have distinctive corporate structures. The most important distinction, however, is that they require new and unique legal resolution schemes when they face insolvency, because conventional bankruptcy processes are likely to raise the specter of systemic risk.

Leverage

The leverage that megabanks – and financial institutions in general, for that matter – employ is especially noteworthy and sets them apart from other companies. Most nonfinancial businesses have debt-to-equity ratios of 1-to-1; for banks and financial firms, the ratio ranges from 15-to-1 to 30-to-1. Moreover, ascertaining the amount of leverage a bank carries is inherently difficult; a small mistake can...

About the Author

Joseph H. Sommer is an assistant vice president and counsel at the Federal Reserve Bank of New York.

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