John FitzGerald: How to contain a bank run in the high-speed age of social media

Bank runs are as old as banks. A panic that leads to a run on some banks can end up precipitating a full financial crisis. In 2007, as rumours circulated about its solvency, we saw how a run on Britain’s Northern Rock bank become one of a chain of events, including the collapse of Lehman Brothers, that resulted in a widespread financial crisis that affected the US, the EU and ourselves in Ireland.

In the last couple of months, a bank run forced the immediate closure of Silicon Valley Bank in the US. Hopefully, the effects of this minor crisis have been contained and will not have ramifications across the global economy.

Banks take deposits that you can withdraw at will, but much of banks’ investment is tied up in longer-term assets such as mortgages. Provided people are happy that the bank is solvent, they leave their money on deposit. However, if rumours circulate that a bank is insolvent, depositors may panic and try to get their money out in a hurry. Under these circumstances, the bank suffering a run does not have the cash on hand to pay out – it cannot suddenly realise long-term assets or force mortgage holders to repay their loans straight away.

To deal with bank runs, central banks have put in place emergency lending facilities to tide banks over an exceptional demand for cash. This facility is open to solvent banks, where assets are genuinely worth more than liabilities. Emergency lending is provided at premium rates, in return for suitable assets provided as collateral. However, it can be difficult for central banks to know whether a bank is genuinely solvent and should be supported in this way, rather than closed down.

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A bank run can impose huge costs on a solvent bank due to losses on forced sale of long-term assets. Hence the need for a central bank backstop

If a bank cannot get emergency support and instead must close down suddenly, the losses for all concerned are much higher than if there is an orderly wind-down. That is because assets have to be sold off quickly at knock-down prices to realise some cash for creditors. A bank run can impose huge costs on a solvent bank due to losses on forced sale of long-term assets. Hence the need for a central bank backstop.

There’s an intriguing study, by UCD’s Morgan Kelly and Cormac Ó Gráda, of an 1857 run on a New York bank. Among the many Irish emigrant depositors, there are interesting differences by county of origin as to who panicked and withdrew their funds.

Unlike in the 1946 film It’s a Wonderful Life, today’s electronic banking meant nobody had to queue outside the bank to get their money

The bank run extended over a fortnight in autumn 1857, with more and more funds being withdrawn by depositors. The bad news clearly circulated among Dublin and Leinster natives, who withdrew their money. Kerry emigrants proved to be equally cute. However those from the northwest, especially Donegal and Sligo, were clearly not in on the rumours, and ended up leaving their money on deposit.

Clearly there needs to be a trigger to start a panic, but once the panic started in 1857, the news spread among friends and former neighbours from Ireland. This study highlights the importance of social networks in fuelling a cumulative run on a bank.

Panic spreads

As in 1857, the recent run on the Silicon Valley Bank in California was fanned by news spreading through social networks. However, the big difference from the 19th century was that, with channels such as Twitter and email, the panic spread in seconds rather than weeks.

Faced with this threat, the chief executive of Silicon Valley Bank held a conference with big depositors on March 9th and told them not to panic. However, his advice was not reassuring, and his words triggered a real stampede, organised on social media.

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Unlike in the 1946 film It’s a Wonderful Life, today’s electronic banking meant nobody had to queue outside the bank to get their money. However, because Silicon Valley Bank had many large depositors, who were not covered by deposit insurance, there was none of the inertia common with small depositors. Within a few hours, a quarter of SVB’s funds had departed.

The modern type of bank run, happening on the internet over minutes rather than days, requires central banks to have new speedy ways to organise their response – and to have rapid ways to distinguish between what banks should be saved and what should be let go under. Another risk is that a fake news story, disseminated on social media, could bring down a solvent bank.

Reflecting this modern environment, former Bank of England deputy governor Paul Tucker has called for a radical overhaul of how banks are funded, so they could withstand a 100 per cent deposit run.