Bailout definition – How do we save banks sustainably?

Bailout of companies Definition and explanation

The pandemic has had serious economic consequences and the state has taken a variety of measures in response. In cooperation with banks, billions of euros in liquidity were made available to companies and short-time working benefits were expanded. Nevertheless, calls for further bailouts are being heard in the political arena as well as directly from companies. The term “bailout” has become established internationally for rescue operations. This term goes back to the bailout of prisoners in the USA.

Bailouts for banks: How does it work?

The bailout simply explained

Bailout refers to financial measures designed to prevent insolvency, over-indebtedness or bankruptcy. The funds are provided by third parties, in particular the state.

A distinction is made between three types of bailout:

  • Private bailout: a company is saved from imminent insolvency by another company or by the state.
  • Subnational bailout: A government institution (for example, a city, county or state) is supported by other government entities to prevent insolvency.
  • International bailout: A state is saved from insolvency by international organizations (such as the IMF or EU) or by another state.

In this paper, only corporate bailout is discussed.

Bailout Measures

The various bailout instruments focus on the liabilities of the failing company.

Classical measures, graded in order of priority, are:

  • Debt rollover: The maturities of the liabilities are delayed.
  • Deferral: The due dates are also postponed for repayment.
  • Debt rescheduling: The goal of this measure is to reduce current expenses. To do this, repayments, maturities and interest rates are changed.
  • Debt consolidation: This measure also aims to reduce current expenses. To this end, short-term maturities are changed to long-term maturities and interest rates are lowered.
  • Assumption of liability: A third party is partially or fully liable for the company’s debts. This takes the form of sureties or guarantees.
  • Partial assumption of debt: A third party partially assumes the debt as sole debtor or as co-debtor.
  • Full debt waiver: The creditors waive repayment of the debt in full.

Bailouts always focus on the measures taken by the state. After all, this means an intervention in the market economy. The following information therefore focuses on this area.

Full insurance for the economy? Discussions about the sense of bailouts

There are always calls for government bailouts. Yet these are not without controversy, especially from an economic perspective. The state tries to do justice to this and generally only intervenes when there is a risk of a domino effect or in the case of so-called systemically important companies.

Advantages of the bailout

Since large companies are involved, the preservation of jobs plays an extraordinary role.

Criticism of the bailout

In principle, companies that become insolvent are eliminated in a market economy. If this does not happen in individual cases because they are helped by third parties, this contradicts the laws of the market. In Germany, the so-called social market economy is one of the main achievements. It is based, among other things, on the fact that the state only intervenes if this can prevent negative effects in the economy as a whole.

The fact that state aid transfers assets in a bailout must be viewed critically. In a bailout, taxpayers finance the creditors of the ailing company. The owners, in the case of stock corporations the shareholders, benefit. At the same time, they alone are entitled to the profits in good times. This contradicts the entrepreneurial idea of being remunerated for the risk taken. With state “insurance,” this remuneration for the risk taken is cancelled out.

The more companies can rely on bailouts, the less incentive there is to prepare financially for times of crisis. The effect will intensify with each crisis. Eventually, more and more companies will realize that they can count on rescue aid. This means that a bailout will punish all companies that operate innovatively and sustainably and accumulate financial reserves.

Last but not least, critics note that in case of doubt, the state is the worse entrepreneur. Past experience has shown that preventing a “market shakeout” is not always the best solution. Identifying market opportunities and investing capital in the right market players are issues that experience has shown are better left to the private sector.

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