27 March 2023

Bruegel's Merler: Fast and furious: how digital bank runs challenge the banking-crisis rulebook

For those hoping that 2023 would bring some respite after the pandemic and war in Ukraine, there has been a rude awakening. Pressured by the fastest monetary tightening on record, some corners of the financial system have cracked. A stream of crypto bankruptcies led ultimately to the demise of crypto-involved Signature Bank of New York (SBNY). Then, in what has been labelled a “Lehman moment for technology”, came the collapse of Silicon Valley Bank (SVB), lender to startups and their venture capital backers. Tensions spilled over to Europe and claimed Credit Suisse, killed, according to its Chairman, by a social media storm.

These bank failures had major differences. But they also share two common traits that raise far-reaching questions.

The first is the speed at which the crises unfolded. SVB announced a plan to raise capital on Wednesday 8 March, but was put into receivership on Friday 10 March. SBNY failed two days later. It took just one day, after incautious comments from its largest shareholder, for Credit Suisse to announce it would take a CHF 50 billion loan from the Swiss central bank.

In a world in which depositors handle both money and information digitally, bank rushes have replaced bank runs. In 2019, Bundesbank President Jens Weidmann argued that digital bank runs could threaten financial stability because they happen quicker and more extensively. He was speaking about the theoretical case of a ‘flight to safety’ towards a central bank digital currency, but the same applies to deposits moving digitally within the banking system.

Social media reinforces the risks. In the midst of the SVB collapse, finance influencers sent panicky tweets that may attract further regulatory scrutiny once the dust has settled. Financial misinformation via social media has proved before to be a powerful crisis engine: in 2011, an unfounded Twitter rumour triggered a bank run on Swedbank and SEB. In 2019, false information in a WhatsApp post led to a run on Metro Bank in the United Kingdom. Credit Suisse itself was taken on by the Reddit crowds in late 2022. Now is the first time, however, that the phenomenon shows potential for systemic effects.

Over-hasty decisions

This leads to the second common aspect of these crises. Because they had to be dealt with in such haste, authorities took problematic decisions with potentially long-term policy consequences.

In an apparent bid to prevent a severe downturn in the startup ecosystem, US authorities said they would guarantee all deposits at SVB and SBNY, about 90% of which were uninsured. Though applicable only to the two failed banks, in practice the decision creates an expectation that all deposits will be treated equally. And in fact US authorities have reportedly started studying ways to protect all deposits in case of a worsening of the crisis. Federal regulators have painted themselves into a corner: once the expectation becomes embedded, reversing it could trigger new panic.

While US authorities were busy subverting the theory of incentives behind deposit insurance, the Swiss Financial Market Supervisory Authority (FINMA) revisited some equally long-held truths about the seniority of creditors. As part of the sale of Credit Suisse to UBS, FINMA decided to write off $17 billion of bonds issued by Credit Suisse without having previously written off shareholders, which are junior to bondholders in banks’ capital structures. The decision triggered a negative reaction in financial markets and prompted European Union and UK regulators to distance themselves from the Swiss approach....

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