Swiss banking regulator adopts bail-ins, but in time of crisis will this work

Reuters reports that the Swiss banking regulators have adopted the following structure for absorbing bank losses before a taxpayer funded bailout: shareholders, contingent convertible holders, unsecured debt holders and then senior debt holders.

While this sounds like a good plan, there is one small detail that hasn't been addressed: implementation during a time of financial crisis.

One of the primary lessons learned from our current global financial crisis is that bank regulators will not require banks to recognize their losses if the result would be to reduce the level of bank book capital.

Why?

For fear of sending a message about the safety and soundness of the banking system.

The result is that bank regulators have an irresistible urge to use taxpayer funds instead.

Regular readers know that the way to end this irresistible urge is to require the banks to provide transparency into their current global asset, liability and off-balance sheet exposure details.

With this level of transparency, market participants can assess and know the current condition of each bank.

Should a bank need to be recapitalized through bail-in, market participants know this and the size of the bail-in.  As a result, actually implementing the bail-in doesn't send a message that threatens the safety and soundness of the banking system.

Switzerland shouldn't bail out its largest banks again before asking creditors and shareholders to stump up, the local financial regulator said on Wednesday. 

Authorities have been grappling since the collapse of U.S. investment bank Lehman Brothers five years ago with the question of how banks regarded as systemically important - or too big to fail (TBTF) - can be recapitalised without causing panic or needing taxpayer cash.... 

The regulator recommended spreading bank losses across a range of creditors, including shareholders, holders of contingent convertible (CoCo) instruments (which may convert into equity under certain conditions) and owners of debt including senior debt. 

"This recapitalisation must be sufficient to meet the needs of all group companies in Switzerland and abroad," FINMA said in its position paper. "This buys time with regard to restructuring the affected banks so that they can return to viable operation."