The credibility of bail-in
Summary
Focus
"Bail-in" means that when a bank fails, its creditors, not taxpayers, bear the losses. It is the alternative to publicly funded bailouts. After the Great Financial Crisis, regulators built a framework to make this credible. The failure of Credit Suisse in March 2023 gave this framework its first major test. A resolution plan was ready to impose losses on Additional Tier 1 (AT1) and bail-in creditors. Bond prices reflected that expectation. However, concerned about financial stability risks, authorities facilitated a takeover by UBS, a large competitor bank, backed by public guarantees. Credit Suisse AT1 bonds were written down in full, meaning investors lost the full value of these instruments, but its bail-in creditors did not bear losses. How did this episode reshape the credibility of bail-in?
Contribution
Credibility is not directly observable, but the extra return investors demand on a bank's bond over a benchmark, the spread, carries its trace. We build a framework that reads changes in credibility from spreads on three types of bank debt that absorb losses in sequence: AT1, bail-in and senior bonds. Comparing these spreads lets us separate two forces: changes in the probability that banks come under severe stress, and changes in the probability that bail-in creditors bear losses once that stress arises. We also test whether market discipline changed, that is, whether investors differentiate between riskier and less risky banks, using bond price responses to earnings announcements.
Findings
Markets drew different lessons for AT1 bonds across jurisdictions. Spreads on these bonds rose in Switzerland, where they had been written down. Spreads fell in the euro area and the United Kingdom, where authorities issued clarifications on the treatment of AT1 bonds. For bail-in bonds, the signal was uniform: spreads tightened across all three jurisdictions. Senior bond spreads barely moved, indicating that markets revised their view on how losses would be allocated, not whether banks would fail. Weaker banks saw larger declines in the cost of bail-in debt. Investors also responded less to bank earnings news. These patterns point to weaker credibility of bail-in and reduced market discipline after the demise of Credit Suisse.
Abstract
The resolution framework for global systemically important banks has been over a decade in the making. The failure of Credit Suisse (CS) in March 2023 was its first major test. Authorities had a resolution plan in place but chose a different path amid financial stability concerns. They facilitated a takeover of CS by UBS, backed by public guarantees. Additional Tier 1 (AT1) bonds were written down in full; bail-in creditors, who would bear losses next under resolution, were left whole. We study how this episode reshaped bail-in credibility across Europe. Using bond-level data from 94 banks in 22 countries, we trace the repricing of AT1, bail-in, and senior debt over the subsequent year. AT1 spreads moved in line with jurisdiction-specific reg ulatory signals, while bail-in spreads and credit default swap subordination premia narrowed across the board, consistent with markets assigning a lower probability to bail-in. Lower-rated banks saw larger spread declines, and investor responsiveness to firm-specific disclosures fell, pointing to reduced market discipline. This evidence suggests the CS episode weakened bail-in credibility.
JEL classification: G21, G28, G01, G33, G14, G12
Keywords: bank resolution, capital regulations, bail-in credibility, Credit Suisse