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This article deals with the architecture and mechanics of the bail-in process. It includes a legal and economic analysis of the challenges facing bail-in centered resolutions and the obstacles to effective cross-border resolutions using bail-in. Public bail-outs of banks are a source of moral hazard, undermining the market discipline. Among the fundamental principles of a free market economy, owners and creditors are supposed to bear the losses of a failed venture. Bail-outs can also have a destabilizing impact on public finances and sovereign debt. These reasons of concern have conducted to reforms to internalize the costs of bank failure of which the foremost is the drawing up of bank creditor bail-ins. Bail-in constitutes a radical rethinking of who bears the ultimate costs of the operation of fractional reserve banking. It has to be considered that the bail-in approach is based on the penalty principle, namely, that the costs of bank failures are shifted to where they best belong: bank shareholders and creditors. Bail-in replaces the public subsidy with a private penalty or with private insurance forcing banks to internalize the cost of the risks they assume. The idea that the penalty for failure can be shifted onto an institution, such as a bank, is incorrect. Ultimately all penalties and similar benefits have to be absorbed by individuals, not inanimate institutions. When it is said that the bank will pay the penalty of failure, this essentially means that the penalty is paid, in the guise of worsened terms, by bank managers, bank staff, bank creditors, or the borrowers. The real question is which individuals will be asked to absorb the cost. Among the conclusions of the authors, it is stressed that imposing haircuts on bank creditors during a systemic panic is a sure way to accelerate the panic. They highlight how the development of a bandwagon may conceal some of the disadvantages of the new bail-in regimes. While the bail-in approach may, indeed, be much superior to bail-outs in the case of idiosyncratic failure, the resort to bail-in may disappoint unless everyone involved is fully aware of the potential downsides of the new approach. The bail-in process seems to be a suitable substitute to resolution in the case of smaller domestic financial institutions, but each plan is deficient and fails to convincingly demonstrate how, in failure, any one of these firms could overcome obstacles to entering bankruptcy without precipitating a financial crisis. Achieving the goal of making private institutions responsible for their actions may represent a good solution. In this sense, financial ‘polluters’ would be held responsible for their actions.
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