Opinion | Needed: a way to slow down super-fast digital bank runs

The current crisis has exposed the Achilles’ heel in the “fractional reserve banking” system that underscores modern Western economies. Banks are required to set aside only a portion, or fraction, of the deposits customers place with them. The rest can be loaned out to people to buy houses, invest in businesses and so on.

The problem with this system is that if all depositors demand their money back at once, the bank won’t have enough to pay everyone. It can’t call in loans or cash in other investments as quickly as it must pay depositors, and that means some of those depositors lose out.

Bank runs are not new. But what has been somewhat novel at SVB, Credit Suisse and First Republic Bank is the speed customers have demanded their money and the manner the runs have spread. Instead of lines of anxious customers standing outside branches, these runs have featured viral rumors on social media and messages exchanged on WhatsApp groups.

Each of these bank runs has had its own distinct context: an over-investment in U.S. Treasurys at SVB and, at Credit Suisse, years of accumulating scandals. First Republic Bank had offered low mortgage rates to wealthy customers, which left it sitting on large paper losses when interest rates rose sharply. On the face of it, these were three banks with only loosely related issues. But in each case, the digital nature of modern banking enabled a rapid meltdown, as customers shifted their money at the touch of a button. There was so little friction, it was easy for customers to think, hmm, might as well move my money elsewhere.

Regulators in the United States have traditionally tried to prevent this kind of thinking by guaranteeing deposits up to $250,000. (Similar safeguards apply in other countries.) But customers with deposits above this level have moved their money to avoid losses, and sometimes even those with funds below the level have followed suit.

What can be done now to prevent the same behavior rippling through the banking world, shifting a wave of deposits to bigger — and presumably safer — banks and leaving behind a trail of destruction?

Several fixes are possible. Cornell professor Saule Omarova has proposed, for instance, that the Federal Reserve offer deposit accounts, all of which would be explicitly guaranteed. Others have suggested that bank regulators start monitoring social media for signs of any developing digital run.

In a new report about the SVB collapse, Michael Barr, the Federal Reserve’s vice chair for supervision, suggests “a stronger supervisory framework” is needed. SVB’s rapid growth had caught regulators off guard, his report found, so that it had become too big, important and risky for its level of supervision.

Rupak Ghose, a former banking sector analyst at Credit Suisse who is now an adviser to the industry, suggests an approach more specifically tailored to the digital age. For starters, Ghose says, bank risk managers and regulators need to stress test a bank’s depositor base to ensure they’re dealing with a diverse group that won’t necessarily act in unison, as happened at SVB and to an extent also at First Republic Bank. And the banks should consider paying higher interest rates on deposits that are above guaranteed levels, to reflect the additional risk that depositors are taking on. Finally, Ghose suggests a more market-based approach to deposit insurance that would allow individual banks (and their customers) to pay a fee to extend deposit insurance above $250,000 per customer.

All these proposals have some merit, though probably none of them alone could stop flighty depositors from effortlessly shifting their money based on a Twitter or Reddit rumor. What’s most needed is for the banking industry to acknowledge that digital deposit runs are different and to address this flaw in the modern banking system.

In the coming months, banks will no doubt lobby against any tightening of regulations — tougher capital or liquidity requirements, for instance. But measures that apply brakes to digital bank runs without meaningfully eating into bank profits should be less contentious. Bank leaders and forward-thinking regulators should put their heads together now.