Music to my ears

From page 67 of the Independent Banking Commission's Interim Report:

4.21 A bank’s loss-absorbing capacity consists of the equity of the owners of the business, and non-equity liabilities or debt, which are contractual claims against the bank.

This section starts with a discussion of equity, the most straightforward and well-understood form of loss-absorbing capacity. This includes an assessment of how much equity systemically important banks should be required to hold.

But debt also needs to be made loss-absorbing, to improve market discipline on banks’ risk taking and to ensure that creditors take losses before the taxpayer. So this section also considers ways in which the effective loss-absorbency of bank debt can be improved.

Three tools are considered:
•debt instruments that absorb loss at some point while the bank is still viable (‘contingent capital’);
•liabilities that absorb loss at the point of non-viability (‘bail-inable debt’); and
•depositor preference, i.e. ranking (at least some) depositors above other unsecured creditors in a bank insolvency, which can have the effect of increasing the loss-absorbing capacity of other parts of a bank’s liability structure.

In simple terms, the Commission suggests a kind of pre-programmed and rolling 'debt-for-equity-swap', the key to this being that depositors rank above bank bonds (quite where you draw the line is a separate issue), only I'm not sure it goes far enough.

Strictly speaking and in any logical world, any deposits covered by the FSCS guarantee (the first £85,000 per depositor, for sake of argument) would rank ahead of any bonds, whether secured, unsecured or otherwise; alternatively, HM Government in its infinite wisdom could just imply a term in its insolvency legislation saying that deposits are in fact secured, and thus are the last to bear losses*, end of discussion.

* For sure, in extreme cases (I'm not aware of any in the UK), a bank might lose so much money that it doesn't even have enough to repay all depositors, in which case the taxpayer has to chip in - with the caveat that any compensation is paid directly to the depositors (as was the case with compensation for people who lost money with Icelandic banks) and not handed over to the bank in return for the vague promise to behave in future.