Can Banks Take Your Money? The Legal and Financial Implications of Bail-Ins

The financial crisis in 2008 was a game-changer in the financial industry. The housing bubble’s collapse led to bankruptcy, which affected even Wallstreet.

The U.S. treasury came in to rescue wall street by giving over 200 billion dollars in loans to hundreds of financial institutions. Even though it was a good amount, it was insufficient as it accounted for only about 30% of the total cost of bailing out the entire Financial system, which is estimated to be 700 billion dollars. Wall Street speculation was to play the blame though only one person went to jail, Kareem Sarah. The SEC allegedly destroyed the evidence given as part of the investigation. The bank bailouts are why Satoshi Nakamoto created bitcoin.

Financial crisis solution — Bail-ins

Politicians had a plan for new regulations. An example is the Dodd-Frank Act.

According to the Dodd-Frank Act, derivatives claims come first in the event of a financial collapse. That means that in the event of a financial crisis, derivatives debt owed by big banks will be paid off before anything else. The difference is that these debts won’t be paid off by bailouts but by bail-ins.

A bailout is when a big bank receives money from someone else to pay back its debts, while a bail-in is when a big bank uses its clients’ money to pay back its debts. It means the bank will use your deposits in accounts or money you lent it to pay debts.

Dodd-Frank Act opened the door to allowing big Banks to use their client funds to 'bail in; themselves in a financial crisis.

The people in power had been working on alternatives to bailouts since 2008. The urgency to develop an alternative to bailouts increased after the financial crisis started to affect Europe.

In mid-2012, the IMF published a paper advocating bail-ins as the ideal alternative to bailouts. It, however, needed a ground to test out the bail-ins.

Cyprus — the testing ground

Cyprus was one of the European countries hit the hardest by the financial crisis. By the end of 2012, Cyprus was desperate for a bailout. In early 2013, the IMF and the European Union bailed Cyprus for 10 billion euros. The IMF gave Cyprus multiple conditions; one was for Cyprus’s largest bank to execute the first-ever bail-in. Almost 50 percent of all bank account balances worth more than one hundred thousand Euros were seized.

The United States was the first to legalize bail-ins in 2010. The Dodd-Frank Act pushed the U.K. to follow suit in 2013. With the financial services act, the E.U. legalized bail-ins in 2016.

Bank Bail-in laws tend to vary from country to country. Although the laws may differ, they follow the same three rules, likely because of their Collective Conformity with the FSB.

The three rules are:

1. Bank bail-ins are only allowed for banks that are deemed to be domestically or globally important.

This rule pertains to those with the most assets under management. The FSB publishes a list of globally important banks every year. There are currently 30 globally systemically important banks, with JP Morgan being noted as the highest risk.

2. Bank bail-ins do not apply to bank balances below the deposit Insurance threshold.

In the U.S., the FDIC covers 250 000 deposits. In the U.K., the FSCS covers 85 000 pounds, and in the E.U., it’s 100 000 Euros with various insurers involved. Insurance funds in the U.S. and Europe are woefully underfunded, particularly when we factor in derivative claims.

Insurers don’t have enough money to cover all Bank deposits. In the case of the FDIC, its 2021 annual report suggests that it only has around 120 billion dollars in its Insurance Fund, which is low compared to the 19 trillion dollars of Bank deposits in the U.S.

3. The third rule of bank bail-ins states that you will be given some alternative asset in exchange for your lost deposits. Alternative assets are typically shares in the bank that you bailed out.

Even though bail-ins may be a good solution for banks and financial institutions, they may be inconvenient to end users. For instance, you could temporarily lose access to your funds during a bank bail-in. Banks could put limits on their hours of operations, payments, transfers, and limits on cash withdrawals until the bail-in process is complete.

Also published here.