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While some of the factors that contribute to the increased volatility of deposits can and should be contained through policy measures, others, like the intensified competition between banks will inevitably stay, and bank balance sheet management and liquidity regulation need to accept the new normal of somewhat less stable and more expensive sight deposits.
The March 2023 demise of some US regional banks and of Credit Suisse suggests that, contrary to expectations, the additional regulatory frameworks introduced after 2008, notably in the field of liquidity requirements, have not overcome the problem of bank runs and the need for central banks to act forcefully as lender of last resort. Quite the contrary, the observed bank runs were of unprecedented speed, and central bank measures were equally unprecedented, such as providing liquidity against collateral at nominal value without a haircut. Policy makers like Federal Reserve Governor Bowman (2023) explained the unprecedented speed of the run on Silicon Valley Bank (SVB) bank as follows:
“For Silicon Valley Bank in particular, … the run … was fueled by the most modern communication methods and social media, and was enabled through new technology that allows customers to move money on a scale and at a velocity not previously accessible directly to customers. …. Back-end money transfer systems have been gradually shifting to real-time payments .... These changes have exacerbated the potential flight risks of uninsured deposits, while changing some of the incentives for depositors imposing market discipline.”
Moreover, the prospects of new forms of money, including means of payments issued by e-money institutions, narrow banks, or stablecoins and central bank digital currency (CBDC) are said to further threaten the stability of cheap bank funding via sight deposits in the future, potentially weakening the business model of commercial banking and its relative importance for financial intermediation.
While the likelihood and severity of bank runs appear to have changed over time, the basic economic logic of bank runs seems to remain unchanged. At least since the 19th century, it is understood that banks can in principle be in three states (for a recent restatement see e.g. Rochet and Vives, 2004, 1133; or Bindseil and Lanari, 2022): (i) a bank can be solid in terms of solvency and liquidity so that their deposit basis and access to funding markets are stable; (ii) a bank can be solvent conditional on sufficient liquidity, but insolvent conditional on certain negative liquidity scenarios because of the implied asset fire sales to be undertaken to address the possible liquidity gaps and related fire sale losses; i.e. the bank is in a multiple equilibrium situation, in which a run could take place or not; (iii) a bank can be insolvent regardless of liquidity scenarios, and in this case, a run of depositors and a loss of funding market access are quasi certain (once the solvency situation is known).
Banks can be pushed from state (i) into state (ii) or (iii) by a negative asset value shock. Banks can also be pushed from state (i) to state (ii) when asset liquidity alone deteriorates, or if the central bank suddenly narrows its collateral eligibility or increases haircuts. Vice versa, the central bank can, by making its collateral framework more supportive, push banks from state (ii) into state (i), but never from state (iii) to state (i) or to state (ii). Therefore, the lender of last resort (LOLR) should only be considered for solvent institutions.
Technological change does not alter this overall economic logic of bank runs but matters in particular for the speed of bank runs in state (ii) and (iii) and for the likelihood that in state (ii) the run equilibrium will prevail. For policy makers this matters a lot because central banks must be even more well prepared to take the right decisions quickly in case banks migrate because of exogeneous shocks out of state (i): act forcefully as LOLR in state (ii) and close the bank in case of (iii)....
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