Bank runs in the digital era

There is a physical element to the archetypal bank run. First of all, you have to get to the bank. Then you have to queue. Then you need to carry or wheelbarrow your money out of the building.

So what happens to bank runs when banks, like everything else, become websites?

It’s on this note that we’d like to hone in on former Canadian central banker Mark Zelmer’s independent review into the UK’s Co-operative Bank, published this week.

The report has received attention for providing one of the first clear critiques of new post-crisis regulations designed to stabilise the banking system. But it’s his comments about bank runs and their relationship to the digital era that got our attention.

He argues that “past experience” has shown how quickly runs can take place in a digital world, and that the risk may grow due to the introduction of Open Banking, which was introduced in the UK last year to require banks to allow third parties to access account data. From the report:

An important feature of many Open Banking concepts is that they essentially facilitate the introduction of third-party agents that stand between a bank and its depositors to help the latter manage their money in more effective ways. If implemented properly, Open Banking may help bolster competition and innovation in the financial sector to the betterment of consumers and the economy more generally. However, this may come at the cost of less stable deposit-taking institutions.

Mr Zelmer then goes on to separately highlight the case of Home Trust in Canada, which suffered depositor flight in 2017 after investment firms became reluctant to place customer money there. On this, he concludes:

An important lesson from the Home Trust incident is that third parties may be highly motivated to move money away (or encourage their deposit clients to do so) from a potentially troubled institution at the first hint of any problems, no matter how strong the deposit insurance scheme or the resolution toolkit. Why? Because no intermediary wants to risk its reputation by having to explain to its depositor clients why their money is on deposit with a troubled institution even if the risk of actual loss is virtually nil. Thus, I would not be surprised if smaller institutions find their deposit bases become less sticky over time and more likely to run at the first hint of troubles.

The overall role Open Banking will play in the allocation of capital is still unclear. What is more clear is that the behaviour of depositors now has to be understood in an online context.

This was evident in the very specific example of environmental activism against banks that provided credit to the Dakota Pipeline, where the strategy was to encourage depositors to shift their funds elsewhere — a kind of green run on the bank.

This risk is not new. A Reuters article from 2008, cited in Zelmer’s investigation, focused on a “silent run” at Fortis, a Belgian financial company which was bailed out, broken up and sold during the crisis.

One critical difference with a traditional bank run is that, in a digital run, the money presumably stays within the banking system, but is moved to another bank. This doesn’t necessarily avoid the systemic issues arising from the situation, however, if the bank in question cannot meet commitments elsewhere.

What is newer, and hinted at in the report, is the role of third party businesses as part of the growing integration of social media and the financial system. In the search for the next crisis, this trend is much less heavily scrutinised than the familiar features of the last one, like house prices or the cost of credit. Once, you closed down the bank. Now, it’s the internet you’d have to close.

Related Links:
The new green evangelism — FT Alphaville
An environmental run on the bank
— FT Alphaville

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