October 18, 2016 Leave a comment
A bank run is when an institution runs out of money to give depositors who are withdrawing money from the bank. This typically happens when a large number of people withdraw money at the same time. Is this still a problem today?
Bank runs would get started when depositors needed to withdraw money due to a catalyst such as a market crash. This would force people to sell assets or pay down loans suddenly creating a surge in the need for cash. This catalyst usually comes from outside the bank. The classic bank run mentality led to the fear that there was not enough money on deposit at the bank, causing an acceleration of withdrawals and leading to bank insolvency.
At the present time, there are new factors that affect how a bank run can happen. The first one is when the bank model of doing business is not profitable. A bank would typically collect deposits from savers and give them interest, and lend this money to borrowers and charge a higher rate of interest. What if a bank charges you money to make a deposit instead of giving you interest? This reality can come from “negative interest rates”, and it is happening in Europe and Japan right now. It may happen in the U.S. and Canada at some point. The banks are being charged interest on money they park at the central bank for the purposes of keeping their “reserve ratio” intact. This reserve is money used as a backstop to fund large amounts of withdrawals that may occur at any given moment. The banks are charging depositors to keep money in accounts to try to recover these charges from the central bank. Mortgage rates would still be higher than the rates on deposit, but the difference between them would shrink. Depositors may in turn withdraw money from their accounts and keep it in cash because it is cheaper than keeping it in a bank. This effect would multiply resulting in a cash shortage at the bank.
The second challenge is the electronic form of money. Bank runs in the past involved physical currency and having to go physically to a bank to make a transaction. What if bank machines stopped working or accounts disappeared? This can happen as a result of hacking, computer viruses or a defect in the computer programming of the bank. If an event like this was made public, the ensuing loss of trust and possible panic could prompt a large number of withdrawals.
The third possibility is a bank “bail-in”. This is when banks lose so much money that they take money from depositors’ accounts to make them whole. Should this possibility arise, the classic bank run can happen is people may want to turn their account balances into physical cash to avoid it being confiscated. Many countries have passed laws allowing these types of bail-ins to happen. What about government backed deposit insurance? This did not exist in the past when there were many bank runs but it exists now. The issue with the insurance is: will it work? The insurance is akin to a type of government bail out of the banks by the taxpayer, similar to what happened in 2008 in the U.S. What if the claims on the insurance fund are very large? The insurer will run out of money quickly and the insurance may not pay out. In the case of the government, the national debt would rise and the taxpayer would be paying additional taxes in future years. This is similar to a large number of claims made against an insurance company and the company would have to raise premiums to recover the payout amounts.
A bank run can happen at any time since people may decide to withdraw money in large numbers for a number of reasons. The difference today is that the banking system has changed and there are other factors that have been added recently that complicate any predictions.