Blog article
See all stories »

In the Blink of an Eye: How the Digital Age Intensifies the Risk of Bank Runs

Recently several medium-sized banks in the US (i.e. First Republic Bank, Silicon Valley Bank and Signature Bank) came into trouble, after their customers lost trust (i.e. the trust of being able to retrieve their money at any moment) in these banks. This resulted in an unstoppable and lightning-fast run on the bank.

Analysts call the collapse of Silicon Valley Bank (SVB) the first digital bankrun or also the first Twitter-fueled bank run. The incredible speed of this bankrun was in any case never witnessed before in the history of banking. In the largest bank failure in US history, i.e. the one of Washington Mutual Bank in 2008, customers took 10 days to withdraw $16.7 billion, while in the case of SVB $42 billion were withdrawn in a single day and another $100 billion were queued up for the next day.

These staggering figures have shaken up the entire worldwide financial system. In today’s interconnected world, where information travels at lightning speed and financial transactions can be executed in seconds, the risk of a "run on the bank" has intensified. Historically, it would take months for such runs to gain momentum, but the digital age has altered the dynamics significantly. Clearly no bank can withstand a bank run at such an unprecedented speed. Therefore every player in the financial industry (regulators, Fintechs, incumbent financial players…​) is now analysing what can be done to avoid this in the future.

But before looking at potential solutions, it is important to understand why those collapsed banks, which were considered (relatively) healthy before the rumours started, were more vulnerable to such a digital bank run than other banking players in the market, i.e.

  • All those banks offered their services to a specific niche customer segment, i.e. SVB to tech start-ups, Signature Bank to crypto-investors and First Republic Bank to a new generation of high-net worth individuals. Such a specific customer focus allows to grow quickly and offer very tailor-made services, but it also means that there is a lack of differentiation and that rumours spread much faster as all clients are frequenting the same (social) networks (i.e. they are strongly interconnected) and have a similar reaction to financial news.

  • The customers they were serving were forced in recent months - due to external factors - to withdraw more money than than they deposited , i.e.

    • SVB: tech start-ups are facing less and smaller VC funding rounds, meaning these companies are forced to gradually consume the deposits they raised in past funding rounds to pay for their ongoing businesses.

    • First Republic Bank: with nearly two-third of deposits not insured by the FDIC (i.e. the federal guarantee for up to $250,000 per person and per bank), these wealthy customers started fearing for their money after the collapse of SVB and Signature Bank. Therefore a lot of those customers started withdrawing all money above $250,000 and spreading it over multiple banks, which was particularly painful for First Republic Bank.
      The same phenomenon accelerated also the fall of SVB and Signature Bank, which respectively had 94% and 90% of deposits uninsured. When comparing this to the large US banks, which only have 47% uninsured deposits, you can see already a dangerous pattern.

    • Signature Bank: the customers of this bank being very active in the crypto-world faced obviously serious issues after the price collapse of crypto-currencies and especially with the bankruptcy of several large crypto-players (like FTX, Three Arrows Capital, Genesis, BlockFi, Celsius, Voyager Digital…​).

  • These banks were all well digitized and all had digital-savvy customers. This meant that withdrawals happened almost all digital, which obviously accelerated enormously the process.

  • The capital rules of those banks were less strict than larger banks in the US and banks in general in Europe. This was due to an exception made by the US government, allowing banks with balance sheets below $250 billion not having to follow all the Basel III rules. Additionally these recent events also learned that the Basel III rules are probably no longer fitting with this fast digital world and require some revision to better factor these types of exceptional, short-term liquidity needs into account.

  • All those banks had a strong asset-liability mismatch, which was due to the type of business those banks were doing, but also a direct consequence of the exceptional monetary policy of central banks in recent years, i.e. after several years of interest rates close to zero (or even negative interest rates), the central bank interest rates have been considerably increased in recent months. This situation made those (but also many other) banks very vulnerable, as they had quite some long-term assets on their balance sheets. Those long-term assets (like loans and government bonds) were acquired in times of low interest rates, which means that a forced liquidation on the secondary market (to free up liquidity for paying back deposit withdrawals) resulted in serious losses (prices of those asset dropped due to the increased interest rates). A better hedging against the interest rate risk seems to have been neglected, but obviously this is easily said in retrospect.

The above elements show some fundamental concerns with our current banking system:

  • Due to the enormous digitalization in the financial industry in recent years (strongly accelerated due to Covid), the speed of deposit withdrawals has now such a speed, that it is nearly impossible to take corrective actions (like raising additional funds, changing certain business rules, obtaining emergency funding from central bank…​) once the first signs of a bank run start to unfold. Before this digital age, banks had some time buffer to properly address liquidity challenges.

  • Rumours spreading like wildfire: social media platforms can spread rumours, often unfounded or fake, like wildfire, triggering panic and undermining the stability of even the most reputable financial institutions. Additionally once such rumours gain traction, they become nearly impossible to halt, as any communication by the bank rarely has a calming effect in these situations.

  • No bank is capable to stop such a Run (even the most profitable ones), meaning it can potentially hit everyone. This means these scenarios become critical operational risks, as these kind of events are an immediate threat to the bank’s survival. When occurring, all shareholder value can be completely destroyed in a matter of a few days (which is the case for these 3 banks).

  • Trust is lost in a day, but takes very long to (re)gain. This means that even a small rumour can have enormous consequences, as even in the positive case that a run on the bank can be avoided, it will require enormous investments to regain trust from customers.

  • The asset-liability mismatch (i.e. banks primarily invest long-term in illiquid assets but face the need to satisfy immediate demands for cash withdrawals), which is at the foundation of banking, can be very problematic in this digital age and in this economic situation, with fast changing central bank interest rates.

As a result, changes to the banking system are required to protect banks against this new digital evolution.
Some examples could be:

  • Banks can consider implementing measures to limit the amount of funds that can be held in certain types of accounts (like current and saving accounts). For example, they can impose maximum limits on deposit amounts or apply lower or even negative interest rates for large deposits. This encourages customers to spread their funds across multiple banks or invest in longer-term deposits or in off-balance securities, reducing the risk of sudden withdrawals.

  • Several Fintechs are already exploring (or even offering) solutions to easily spread money over different banks (when the deposited amounts surpass the government bank guarantees). Via some kind of aggregating BFM/PFM app, which has access to all your bank accounts, accounts with too much deposits can be easily identified and the excess money can be automatically moved to banks where the guarantee limit is not yet reached. Additionally the app could allow easy opening of additional accounts at other banks, when the limit is reached on all accounts at current banks. Especially for businesses, which typically have large cash pools, such tooling can become a necessity.

  • Governments or collective actions among banks can explore options to increase the level of deposit insurance or guarantees. Such actions can help increasing confidence in the banking system and reduce the likelihood of runs on the bank.

  • Effective communication and transparency: fast, transparent and honest communication with depositors, shareholders, and regulators becomes essential. Banks should proactively disseminate accurate and timely information to counter false rumors and allay concerns. Additionally they should put in place systems to continuously monitor social media (several platforms exist on the market for this, like Hootsuite, Mentionlytics, Reddit, Brandwatch, HubSpot, Keyhole…​), allowing to pick-up on rumours or other potential harmful communications instantly, so that immediate action can be taken.

  • Enhancing liquidity management: banks should develop robust liquidity risk management frameworks to ensure sufficient reserves are available to meet depositor demands during periods of stress. Maintaining a diverse funding base and regularly stress-testing liquidity positions can help identify vulnerabilities and facilitate proactive measures.

  • Changes in Basel III calculations: currently the Basel risk-weighted capital requirements are mainly based on the credit quality of a bank’s asset portfolio. In the case of SVB, this was positive, as it had a lot of long-term government-backed securities with very low credit risk in their portfolio. Specialists are therefore suggesting to take interest rate risk more into account in the risk-weighting formulas.
    Additionally experts suggest to review the rules for calculating LCR (Liquidity Coverage Ratio, i.e. the quality and liquidity of assets) and NSRF (Net Stable Funding Ratio, i.e. the quality and stability of liabilities, meaning the funding sources). Clearly the recent events have showed that the definitions of a stress-situation might have to be reconsidered and also the definition of quality needs to look more at the interest rate risk.

  • Asset-liability mismatch: as an asset-liability mismatch is at the heart of banking, the delicate mechanics of this mismatch should be carefully monitored. This means banks have a strong responsibility to better monitor this and hedge themselves against certain risks (like interest rate risk), but at the same time there is also an important responsibility for Central Banks and politicians in this story.

    • Central Banks might want to be more careful in using the central bank interest rate as a tool to intervene in the economy. Although the central bank interest rate is considered by economists worldwide as a powerful tool to reduce economic fluctuations, we see now that a too dynamic policy of the central banks (via changing interest rates and via quantitative easing) also has quite some adverse effects on the long-term.

    • Politicians need to be careful with certain regulation in the financial sector aimed to help consumers, but in the long-term potentially increasing the risk in the financial situation. E.g. in Belgium there is a strong push from the government upon banks to rapidly increase the interest rates on saving accounts. Currently the 4 major banks in Belgium provide an interest rate on saving accounts of around 0.5%, while if they park the money of those saving accounts at the ECB they get themselves an interest of 3.25%. This difference has never been so big, hence the public push on all banks to rapidly increase this interest rate.
      Despite the fact that banks in Belgium, due to a lack of competition and a lack of mobility of savers, the delicate balance of the the asset-liability mismatch should not be overlooked.
      A lot of assets of the bank (i.e. credits and investments in instruments like government bonds) were originated/purchased a few years ago, when interest rates for credits were still at 1% and less and a lot of those are quite long-term. This means the Belgian banks are still carrying these long-term, low-interest assets for quite some time. When increasing the interest rates on saving accounts too quickly, this can create a bigger mismatch.
      This shows that the short-term demands of customers rarely align with the long-term stability concerns of a bank.

Clearly these are interesting times, with dynamics changing faster than ever before. This means that banking management and regulation need to rapidly evolve as well. Unfortunately the complexity of the financial system makes it very difficult to understand all dynamics in detail, meaning that we probably need events like the bankruptcy of SVB, First Republic Bank and Signature Bank, to better understand and adjust certain rules and guidelines to our modern digital times.

Check out all my blogs on https://bankloch.blogspot.com/

 

7967

Comments: (8)

Ketharaman Swaminathan
Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune 02 June, 2023, 11:281 like 1 like

Limiting deposits will reduce the size of bank balance sheet. Not sure how many bank shareholders will approve of that measure. 

IntraFi and Mercury are two fintechs who already offer Brokered Deposits / Sweep of the nature you've mentioned to move deposits across multiple banks.

As soon as news of SVB troubles began, T-Sec Janet Yallen was reported saying that Unlimited FDIC Insurance was on the cards. Two days after SVB troubles were bedded down, she was reported saying there was no plan for Unlimited FDIC Insurance on a blanket basis. 

Most measures have proponents and opponents in the banking industry, regulators and government. 

I'm guessing the other measures would require fresh law making in the Congress.

The big elephant in the room is withdrawal restrictions. With due respect to all the other measures, the only one really needed to prevent a bank run is placing a limit on withdrawals from bank accounts. While it will deal a big blow to people's confidence in the banking system, there's nothing much anyone can do if it's imposed by statute on all banks. The more regulators and public apply Drunk Under Lamp Post regulation on banks for APP Scam compensation, the easier it will be for banks to justify withdrawal limits as a fraud mitigation measure.

Anthony Pickup
Anthony Pickup - Capgemini Invent - Manchester 02 June, 2023, 13:501 like 1 like

One area that the AI generated Fake news may also drive runs on Banks and Markets in general - https://www.itv.com/news/2023-05-23/fake-ai-created-image-of-pentagon-explosion-sparks-brief-panic

Where does the liability sit where fake news drives a run on a stock ...

Ketharaman Swaminathan
Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune 02 June, 2023, 16:52Be the first to give this comment the thumbs up 0 likes

In all probability, the perpetrator of the fake news will be some rando fake news peddler with meager resources. The trick will lie in applying Drunk Under Lamp Post regulation such that you can nail the party that has enough resources to be able to discharge the liability - whether they were actually responsible for the fake news will be secondary:).

Unlike banks, social networks enjoy Section 230 safe harbor for content posted on their platforms, so it will be interesting to watch who finally is held liable for the fake news. 

Joris Lochy
Joris Lochy - Capilever - Brussels 02 June, 2023, 22:12Be the first to give this comment the thumbs up 0 likes

Many thanks for the interesting comments.
I fully agree that general regulation (applicable to all banks) will be most effective, otherwise commercial short-term gains will always attract certain banks to take more risk. These general regulations will however take time and after all lobbying will always be some kind of half-baked compromise. 

But I do also believe banks can also do a lot themselves. In above comment "Limiting deposits will reduce the size of bank balance sheet. Not sure how many bank shareholders will approve of that measure." I agree that banks will never limit deposits, but they can limit deposits on saving account, when they can ensure the money is put in term deposits at the bank or invested in securities. Often those products gain even more money to the bank than saving deposits and they don't bear this risk of immediate liquidation in case of panic.

Interesting views also on who is to blame for fake news put on social media. This is a very interesting discussion, but it's a discussion for lawyers and politicians. Once panic breaks out, all harm is already done and this harm can not easily be undone even when the perpetrator of the fake news is identified and it is confirmed that the news is fake. As a bank, you should therefore also take action to protect you against fake news, even if illegally spread. In this digital age, you won't have the time to go to court and obtain confirmation of the fact it was illegal fake news.

Ketharaman Swaminathan
Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune 03 June, 2023, 12:32Be the first to give this comment the thumbs up 0 likes

Sorry but "... those products ... don't bear this risk of immediate liquidation" is wrong.

A bank can invest customer deposits in a lot of places but, according to the basic principle of DDA, it MUST let the customer withdraw it ON DEMAND (subject to business hours, functioning of online banking, etc.). It's the bank's job to arrange for liquidity. 

SVB did invest customer deposits in 10 year T-Bonds but it couldn't refuse customers to withdraw their money when they wanted. If only SVB could have told customers "Hey we've invested your deposit in 10 year T-Bond, wait for 10 years to withdraw it", it would not have failed in the first place. 

Joris Lochy
Joris Lochy - Capilever - Brussels 04 June, 2023, 13:14Be the first to give this comment the thumbs up 0 likes

Sorry, I think there is a misunderstanding of what I meant here with term deposits. Indeed obviously if the bank invests my saving deposits in term deposits or any othe bonds this doesn't change anything to the liquidity of my saving deposits. 

What I mean here with term deposits, is that the customer invests directly his excess saving deposits in term deposits. This could be government bonds, but also term deposits offered by the bank. It's this last type I am referring to here. When term deposits are offered by the bank, the amount and duration can be very flexible, making it a good complement for saving deposits. The big difference with those term deposits (typically with maturity of 3, 5 or 10 years), is that the customer has to pay a penalty if he wants to liquidate them before maturity date. This makes the customer less inclined to quickly liquidate in case of a panic.

Nahum Goldmann
Nahum Goldmann - BelPay.be - Ottawa Canada 05 June, 2023, 02:591 like 1 like

Joris congratulations, great analysis!

Of course, the ultimate solution to this existential challenge is simple and obvious -- with the introduction of THE central bank digital currency, there won't be much objective need for investment banks (and, as an additional bonus, Dr. Janet Yallen won't be able to talk out of both sides of her mouth).  This will definitely protect THE financial system, once and forever.

Let's assume that the time will come fairly soon (2030?) when at least some central bankers of the world would become digitally literate -- and will thereafter sort it all out.  There is a rumor that in the new virtual paradigm bankers are now allowed to dream 24/7/365 about universal all-encompassing QE.  But perhaps it is just a fake rumor.

Hope you are doing fine.

Kind regards

Nahum Goldmann

 

Ketharaman Swaminathan
Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune 05 June, 2023, 10:591 like 1 like

Most banks in USA - including SVB - offer virtually 0% interest on checking accounts. Moving money to term deposits will increase their interest outflow, which will dent their profits, which will hammer their share price, which will cause crisis of confidence, which will end up causing more-or-less the same problem as we have now, just from a different angle. 

To cite Matt Levine, the key disconnect is that banks believe that banking is a Theory 2 business in practice even though it's contractually a Theory 1 business. In the past, their belief has been vindicated.

Only time will tell whether they will see the failures of SVB et al as proof that banking is really a Theory 1 business in practice or they will shrug those failures off and continue to believe that banking is a Theory 2 business.

Joris Lochy

Joris Lochy

Product Manager at Intix | Co-founder

Capilever

Member since

05 Apr 2017

Location

Brussels

Blog posts

123

Comments

19

This post is from a series of posts in the group:

Banking Strategy, Digital and Transformation

Latest thinking in respect to Banking Strategy, Digital and Transformation. Harnessing our collective wisdom to make banking better. Ambrish Parmar


See all

Now hiring