When a systemically important Swiss bank encounters a crisis, it initially takes its own recovery measures, for example the sale of individual legal entities or business areas. If the bank is unable to recover independently and is demonstrably in danger of over-indebtedness or has serious liquidity problems, FINMA can decree a bail-in if the bank will meet all its licensing requirements as a result. However, the bail-in must, particularly in the case of a systemically important bank, be part of a prepared recovery and resolution strategy.
The cost of resolving a bank through a bail-in is mainly borne by the creditors. It contrasts with a bail-out, where the cost of and resolution is borne by the government and thus ultimately by taxpayers. Creditors’ participation in the rescue of a bank represents a genuine paradigm shift and is the key to making the implicit state guarantee for systemically important banks a thing of the past.
In principle, all debt claims against banks – with few exceptions – are subject to statutory conversion into equity or statutory reduction. In the case of conversion, the hierarchy of creditors must be observed, and no category of creditors must end up receiving less than they would in the event of bankruptcy. The bail-in does not include secured, privileged and offsettable claims. Privileged bank deposits up to CHF 100,000 are thus not affected by the bail-in.
The successful implementation of the bail-in as a resolution measure requires a sufficient quantity of liabilities that can be “bailed in”. International, systemically important banks must therefore for the event of a crisis maintain additional loss-absorbing capacity (liabilities) in the same amount as their going concern requirements (total loss-absorbing capacity, TLAC). Domestic systemically important banks are also subject to this requirement with effect from 1 January 2019, although they must only maintain forty percent of the going concern requirements as additional loss-absorbing capacity.
Part of the liabilities has to be “distributed” within the Group structure in such a way that they are issued by the major subsidiaries and held at the level of the highest group company or non-operational holding company. In the event of a crisis, these claims are used to absorb losses prior to distribution to all other creditors of the subsidiary. This ensures that the domestic and foreign operational subsidiaries can maintain the functions critical to systemic stability throughout the entire restructuring process. This also reduces the risk of the group bail-in resolution strategy being placed in jeopardy by insolvency proceedings launched by local creditors regarding legal entities in another country.
Contingent convertible bonds or bonds with a conditional debt waiver were incorporated into banking law in Switzerland with the “too big to fail” regulations. Debtors and creditors enter into a contractual agreement that, if a predefined trigger event occurs, such as falling below a certain capital ratio, the claims are written down or converted into equity.