European Central Bank Preparing for Bail Ins & Banking Collapse

Bail-ins and bailouts both serve the same purpose: they are designed to prevent the complete collapse of a failing bank. But the difference between the two lies primarily in who bears the financial burden of rescuing the bank.

With bailouts, the government injects capital into banks, enabling them to continue their operations. During the financial crisis, the government bailed out major banks by injecting $700 billion into names like Bank of America (BAC), Citigroup (C), and American International Group (AIG). Since the government doesn't have its own money, it must use taxpayer funds.

Bail-ins work a little differently, providing immediate relief. Banks use money from their unsecured creditors, including depositors and bondholders, to restructure their capital to stay afloat. Put simply, they can convert their debt into equity to increase their capital requirements.

Although depositors run the risk of losing some of their deposits, banks can only use deposits in excess of the $250,000 protection provided by the Federal Deposit Insurance Corporation (FDIC).

Bailout vs. Bail-In At a Glance

Bank Bailout: The government uses taxpayer dollars to buy out toxic assets and infuse capital into failing banks to keep them from going under.

Bank Bail-In: Rather than using taxpayer money to infuse banks with capital, banks can seize money from depositors, turning debt into equity to keep the bank afloat.