A ‘Bail-In Hierarchy’ defines the order in which a failing financial institution’s (or a regulated crypto entity’s) liabilities are reduced or converted into equity to absorb losses, thereby recapitalizing the entity without public funds. This mechanism prioritizes senior creditors and depositors, imposing losses first on shareholders and then on progressively more junior creditors. Its purpose is to maintain financial system stability and reduce moral hazard.
Mechanism
The operational mechanism involves a predetermined legal framework that specifies the ranking of an institution’s debt instruments and other liabilities for loss absorption. Upon a trigger event, such as a regulatory determination of non-viability, unsecured creditors face conversion of their claims to equity or principal write-down, following a strict order of subordination. This conversion injects capital, allowing the entity to continue critical operations.
Methodology
The methodology for implementing a bail-in requires clear legislative provisions and robust resolution planning by authorities, delineating eligible liabilities and conversion rates. Strategic considerations include assessing an entity’s bail-in capacity, ensuring operational continuity post-bail-in, and minimizing market contagion. For crypto, this involves adapting traditional financial resolution tools to decentralized structures and digital asset liabilities.
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