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Just to be clear, the bank holds more assets than its liabilities, otherwise it would have gone bankrupt. It just happens that a lot of these assets are themsel
by cm2187 6y ago
Just to be clear, the bank holds more assets than its liabilities, otherwise it would have gone bankrupt. It just happens that a lot of these assets are themselves IOU from private customers, usually backed by a property asset.
- rkagerer 6y agoThanks, great point. I updated my remark to say "cash assets" and I'm open to better phrasing.
- jonahbenton 6y agotypo: s/bankrupt/insolvent/ As you're probably aware, bankrupt is not a relevant concept for banks. Creditors- depositors- do not get a haircut, their deposits are insured.
- cm2187 6y agoNo, banks can go bankrupt like any other company. I think you are refering to Chapter 11 (in the US), which is true, isn't practical for a bank, because the bank has no other business than being trustworthy to its creditors, so it couldn't really operate under Chapter 11. The deposit insurance only applies to deposits below a certain threshold and doesn't concern the bank, it just means the state will make the customer good for its loss in a bankruptcy. Now in practice central banks will do everything they can to avoid getting there, first by forcing banks to hold a lot of capital and liquidity. But it can still happen, and one of the tools available is bail-in, which effectively replicates the effect of a chapter 11 over a week end, outside of courts. I think in most jurisdictions, wholesale creditors are the most likely to get a haircut in a bail-in, and the insured part of the deposits is explicitely non-bailinable. But any deposit above the insured threshold can in theory be affected by a bail-in and have a haircut applied. But a lot of fail safe mechanisms will have failed before that happens.
- jonahbenton 6y agoThanks, yup- to be more precise, a state of insolvency- liabilities > assets at close of business- may result in one or more outcomes, one of which is essentially bankruptcy + bail in, but another might be, eg being absorbed/acquired?
- cm2187 6y agoCorrect. Though just to be precise, a bailin would happen well ahead of a bankruptcy, the regulator wouldn’t wait for the situation to be that bad to call the bank non viable (except in a jump to default scenario). Absorbed/acquired: that’s a bailout. Always an option but I think everyone agrees no one wants to see that happen again unless it is a willing private buyer.