PLANS to require creditors of banks that get into financial trouble to be "bailed in" may be good news for vulture funds and lawyers but do little to improve the financial system.
The warning comes from a former member of the Bank of England's key Monetary Policy Committee who highlighted the risk involved in bail-ins at a conference in Edinburgh.
Professor Charles Goodhart said proposals to require bond holders to trade some of the debt they hold for equity, which have been welcomed by George Osborne, could trigger a range of unintended consequences.
Director of the Financial Regulation Research Programme at the London School of Economics, Mr Goodhart said bail-ins could result in investors that specialise in buying distressed debt, acquiring significant shareholdings in UK banks.
Noting the £1.5 billion bail-in proposed at the Co-op Bank, Mr Goodhart said: "The people who come in will be the American vulture funds."
He said Russian depositors acquired significant positions in the Bank of Cyprus following a bail-in last year.
Mr Goodhart warned attempts to require bank creditors to trade debt for equity could involve big legal complications.
"It's legal heaven," he told a conference on banking regulation at Edinburgh University. "Everyone is going to sue everyone and the suits will go on for ever."
Mr Goodhart believes bail-in provisions could frighten off overseas investors in bonds issued by UK banks.
He said UK pension funds may be left to fill the gap. This might have implications for the returns generated by the funds.
At the same time, Mr Goodhart noted banks would probably have to pay higher interest rates on bonds with bail-in provisions to persuade investors to buy them.
The Government-appointed Banking Commission suggested bank executives should get some of their bonuses in the form of bail-in bonds.
The Co-op Bank wants junior bond-holders to exchange some debt for equity. Some junior bond-holders, including America's Aurelius Capital Management and Silver Point Capital, want to take over the bank.
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