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Business News/ Industry / Banking/ Huw van Steenis suggests how digital bank runs can be prevented

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Huw van Steenis suggests how digital bank runs can be prevented

5 min read 08 Jun 2023, 05:47 PM IST Join us

The Economist

The former adviser to the Bank of England thinks slowing the shift to digital currencies will help

Silicon Valley Bank lost $42bn – more than half its demand deposits – within hours, while Signature Bank lost a fifth of its deposits in a few hours on the Friday before it was closed (Photo: AP)

In his book “The Best Way to Rob a Bank is to Own One" Bill Black argues that the 1980s savings-and-loan (S&L) crisis in America was exacerbated by three Ds: “deregulation, de-supervision and de facto decriminalisation". The failures of Silicon Valley Bank (SVB) and three other lenders last month share many of the hallmarks of the crisis a generation ago, when one in three S&Ls failed. Today there is a fourth D: a digital bank run. The ability of consumers and companies to move millions, or billions, with just a few clicks has profound implications for banks and regulators.

Deposit flight is not new. But the pace and scale, amplified via social media, has shocked bankers and their overseers. SVB lost $42bn–more than half its demand deposits–within hours. Signature Bank lost a fifth of its deposits in a few hours on the Friday before it was closed. “It’s a complete game-changer," said Jane Fraser, CEO of Citigroup, an American banking titan, last month.

Money-market funds were the big winners of the panic in March, drawing in more than $340bn across the month as jittery savers sought a haven for deposits they had pulled from banks. The irony of this is that the money-market funds could only absorb this flood at an attractive rate because they can funnel inflows into the Fed’s overnight “reverse repurchase" facility, effectively giving them access to a reserve account. The facility, introduced in 2013 as a temporary policy tool to help control the federal funds rate, may instead have destabilised finance–by easing nervy bank depositors’ path to a safe-looking alternative (“flight to quality") once a run began. The nature and speed of the flight to money-market funds with access to Fed facilities bolsters the argument that there will need to be a re-evaluation of the risks of digital finance.

One of those areas will be central-bank digital currencies (CBDCs), e-money minted by the monetary authorities. There are understandable fears that CBDCs could add to the financial system’s woes, rather than making it more robust.

To some observers, CBDCs complement ongoing reforms. The recent panic saw deposit flight from banks to vehicles that are closer to the state: money-market funds park funds directly on central-bank balance-sheets or in Treasuries. A CBDC account would offer yet another outlet for these funds. Some believe a more centralised digital financial ecosystem built around CBDCs is inherently more stable than a more fragmented one based on privately run digital currencies. Another consideration, say boosters, is financial inclusion: amid the disappearance of cash and the shift to digital money, central banks can design their e-currencies to be accessible to the unbanked.

More than 100 central banks are investigating or piloting the practice of issuing tokens to individuals or banks as an alternative to cash. They are not blind to the risks. To mitigate them, some central bankers advocate a “Goldilocks" CBDC: with not so much in circulation that it causes a run on the banking system, as individuals switch savings to CBDCs, but not so little that it is irrelevant. But the speed and scale of the recent bank runs dwarf any thought exercises among those supporting CBDCs.

The Bank of England has suggested a cap of £20,000 ($25,000) in its plan and will not pay interest on the new digital pound. The European Central Bank has also suggested a limit to just €3,000 ($3,270) per person. Is it really worth the effort and expense of developing something so risky and so limited? Tellingly, the IMF’s enthusiasm has cooled. In a report on the Swedish financial system it recently warned that “the materiality of CBDC risks on the financial system should be further evaluated".

Beyond adjustments on digital currencies, however, how might banks and policymakers fend off digital bank runs? The most obvious and likely move will be to tighten the existing rules. The deregulation of mid-sized American banks in 2018, which exempted them from tough rules on capital and liquidity buffers brought in after the global financial crisis of 2007-09, will need to be reversed. A recent study, published by the Yale School of Management, estimated SVB’s liquidity-coverage ratio at 75%, way below international minimums of 100%. Banks will need to be stress-tested for interest-rate shocks, too. But while stronger shock-absorbers will help, they can only go so far.

Supervision will also need to get smarter about anticipating risks and snuffing them out before they spread. Too many policymakers, worn down by a decade of easy money, were focused on new risks emerging outside the banking sector and missed the old risks in new forms within it: interest-rate risk garnered only a footnote in the Federal Reserve’s most recent Financial Stability Report, released last November.

Now is not the time to charge ahead with innovations that add new concerns. So CBDCs should be kicked into the long grass, at least until we get a much better sense of whether the banks that failed in March were outliers or a sign of things to come.

There also appears to be a failure of nerve to stand up to banks’ management teams, especially since it became apparent last November that rapidly rising interest rates were increasing risk. Having SVB’s boss, Greg Becker, serve on the San Francisco Fed’s own board was not an ideal way to encourage tough love from a supervisor.

During the Great Depression John Maynard Keynes observed, “A ‘sound’ banker, alas, is not one who sees danger and avoids it, but one who, when he is ruined, is ruined in a conventional and orthodox way along with his fellows, so that no one can really blame him." The demise of SVB and others underscores the fact that the financial world still needs to worry about the same old things–especially when they present themselves in new forms. Huw van Steenis is Vice-Chair of Oliver Wyman and served as senior adviser to Mark Carney when he was governor of the Bank of England. He also advises the Norwegian sovereign-wealth fund and sits on the investment committee of the Oxford University Endowment.

Huw van Steenis is Vice-Chair of Oliver Wyman and served as senior adviser to Mark Carney when he was governor of the Bank of England. He also advises the Norwegian sovereign-wealth fund and sits on the investment committee of the Oxford University Endowment.

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