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Part 19. How banks are bailed in

A bail-in is, in fact, similar to a bailout except that deposits of all customers of the bank are written down in exchange for share equity (excluding deposits that are protected, as we will see). Let's go back to the the banks and sets of accounts in Part 18 after the write down of Mortgage Loan Account #1 and the mortgage security. The balance sheet is reproduced in Figure 19.1.

1st Bank's Assets Mortgage Loan Account #1 £90,000 Mortgage-backed Securities £40,000 Digital Reserves £45,000 Total assets £175,000 1st Bank's Liabilities Deposit Account #2 £45,000 Mortgage Loan Account #1 Security £90,000 Deposit Account #3 £10,000 Government's Deposit Account £40,000 Total liabilities £185,000 1st Bank's Equity Equity Capital (£10,000) Total equity (£10,000) brackets around the number indicates it is negative.

Figure 19.1 1st Bank's balance sheet after the mortgage loan write down.

To make the bank whole via a bail-in, we need to transfer funds from deposit accounts to 1st Bank's equity capital account, again in exchange for share equity. Deposit account holders will receive share certificates in exchange for their share equity. We will assume deposits of up to £30,000 are protected and only deposits above this value can be used in bail-ins.

As we have two deposit accounts that qualify (Deposit Account #2 and Government's Deposit Account) and negative equity of £10,000, we will write down each for £5,000. Starting with Deposit Account #2, the transaction for the write down, or compulsory share purchase, is shown in Figure 19.2.

Deposit Account #2 1st Bank Description Debits Credits Balance Previous balance £45,000 (CR) Share Equity Compulsory Purchase £5,000 £40,000 (CR) Equity Capital 1st Bank Description Debits Credits Balance Previous balance £10,000 (DR) Share Equity Sold £5,000 £5,000 (DR)

Figure 19.2 Deposit Account #2 write down.

For the government's deposit account, the transaction for the compulsory share purchase is shown in Figure 19.3.

Government's Deposit Account 1st Bank Description Debits Credits Balance Previous balance £40,000 (CR) Share Equity Compulsory Purchase £5,000 £35,000 (CR) Equity Capital 1st Bank Description Debits Credits Balance Previous balance £10,000 (DR) Share Equity Sold £5,000 £5,000 (DR) Share Equity Sold £5,000 £0

Figure 19.3 Government's Deposit Account write down.

And the balance sheet of 1st Bank is now shown in Figure 19.4.

1st Bank's Assets Mortgage Loan Account #1 £90,000 Mortgage-backed Securities £40,000 Digital Reserves £45,000 Total assets £175,000 1st Bank's Liabilities Deposit Account #2 £40,000 Mortgage Loan Account #1 Security £90,000 Deposit Account #3 £10,000 Government's Deposit Account £35,000 Total liabilities £175,000

Figure 19.4 Balance sheet of 1st Bank after the bail-in.

After the bail-in, 1st Bank is no longer bankrupt, but also has no equity. This is because only the minimum of deposit holders' funds were used to make the bank whole. There are £10,000 less in deposits at 1st Bank as a result of the bail-in; hence, bail-ins also reduce the money supply. The deposit holders are able to sell their shares at a later date to recover their deposits, provided the bank is able to recover its share value.

back to Part 18