What is a bank bailout?

A bank bailout (or bailout) is the action of injecting capital into a banking entity with the intention of saving a situation prior to bankruptcy. This occurs in situations in which a banking entity has not managed its funds correctly and is forced to suffer the intervention of an organization such as central banks. Let's see what bank bailouts are, how they work and which have been the most notorious in history.

What is a bank bailout?

A bank bailout (or bailout) is the action of injecting capital into a banking entity with the intention of saving a situation prior to bankruptcy. The main difference that we can observe between the two terms is the type of entity that is rescued. These bailouts are carried out by organizations such as central banks (Fed, European Central Bank, Swiss National Bank...) due to insolvency or bankruptcy situations that could lead the system to collapse or a contagion effect on other entities. The main victims of these actions are the clients who deposited money in the rescued entities. At the same time, the citizens themselves are also harmed, since this involves the execution of aggressive monetary expansion policies to try to inject liquidity into these entities, which then entails inflationary periods that take time to alleviate. 

Why does a bank bailout happen?

Bank bailouts occur when a financial institution is on the brink of insolvency or bankruptcy. There are a series of factors that can cause a bank rescue to try to save clients' money, among which we can highlight: 

• Insolvency of a financial institution. 
• Loss of depositors' capital. 
• Bankruptcy of a financial institution. 
• Risk of creating a contagion effect on other financial entities, that is, a systemic risk. 

How does a bank bailout work?

A bank bailout It doesn't happen overnight even though it may seem like it on the news.. These processes entail a series of previous steps that must be carefully evaluated and executed. First of all, a study of the situation must be carried out to know the actions that will be carried out to evaluate possible scenarios that may occur and the consequences that they may entail. To put ourselves in context, a bank (or financial) bailout It can cost on average 13% of the gross domestic product (GDP) of the country that carries it out. The phases of a bank rescue are as follows: 

1. Assessment of the situation: First, the situation is analyzed, where the amount of the rescue is assessed, how it could affect the economy and the way to proceed. 
2. Negotiate the conditions of the rescue: At the time that the evaluation of the rescue situation has been carried out, the conditions of the rescue are negotiated with the aim of allowing it to be carried out.
3. Measures to carry out the rescue: To carry out the rescue of a certain entity, austerity measures must be applied, that is, certain conditions must be introduced to the rescue (reduction of public spending and increase in taxes) to allow it. 
4. Rescue consequences: When the rescue has already been evaluated and negotiated, all the measures that must be adopted to carry out the rescue must be taken into account. Among them, the effects that will arise from its application must be taken into account, as well as having a control plan in anticipation of minimizing collateral damage and being able to manage possible risks if they occur. 

What have been the biggest bank bailouts?

In general, when we talk about bank bailouts, the great financial crisis of 2008 always comes to mind, where multiple banking entities required a bank bailout at a time when the contagion effect emerged at a global level. We can mention three periods in which large bank bailouts occurred: 

Year 1991, the real estate bubble in Sweden

In the early 90s, Sweden's housing bubble deflated, leading to a severe credit crisis and widespread bank insolvency. The causes were similar to those of the 2007-2008 crisis. The Swedish government assumed the debts of the banks. This bailout initially cost about 4% of Sweden's GDP, later fell to less than 2% when the nationalized banks were reprivatized.

Year 2008, the great financial crisis overall

The great crisis of 2008 was caused by subprime mortgages. This crisis arose when credit distrust initially spread through the financial markets of the United States and was the alarm that put the "junk" mortgages in Europe in the spotlight since the summer of 2007, evident the following summer with the financial crisis. 2008. Generally, It is considered the trigger of the Great Recession internationally., including the real estate bubble in Spain. The countries most affected by this crisis were Ireland, the United States and Spain, among many others. 

• Irish banks suffered a significant drop in share price due to lack of liquidity at its disposal in international financial markets. In 2010, this solvency is emerging as the most serious concern due to questionable loans made to real estate developers. 
• The beginning of the global crisis meant the explosion of other problems for Spain: the end of the real estate bubble, the banking crisis of 2010​ and finally the increase in unemployment in Spain. According to 2020 calculations, 43.225 million of a total of 64.000 million would be lost (73% of the public aid provided).
• The main culprit of the great crisis was who caused it, where Lehman Brothers, with 639.000 million dollars in assets, declared bankruptcy on September 15, 2008 after the flight of its clients. The Federal Reserve had negotiated its reorganization with other banks, but the discussions failed. In total, the United States bank rescue is counted for a value of 800.000 million dollars. 

Year 2023, the effects of interest rate increases

If we thought we had learned the lesson from previous crises, we were very wrong. After the pandemic that we suffered during 2020 monetary expansion policies never seen before were carried out, something that caused a brief period of artificial economic growth. This situation made us overconfident, where multiple banking entities They did not know how to correctly manage risk when positioning their capital. Last year, with the start of the war in Ukraine and the problems caused by the increase in prices of certain raw materials, many banking entities had in their possession large amounts of bonds that have seen their profitability affected by the increases in interest rates. interest. The result has been rescue by the Fed of entities such as Signature Bank, Silicon Valley Bank, Silvergate and other banking entities in the United States.

On the old continent we have also witnessed how a century-old entity, Credit Suisse, has been forced to be absorbed by one of its competitors, UBS. Although we believe that the situation ends at the moment that the Swiss National Bank (SNB) was going to give him a loan of 50.000 billion Swiss francs (CHF) to alleviate the situation, we are wrong. This is because UBS is also in a risky situation, which has generated distrust on a global scale in banking entities in all regions.