A Modern Look at an Old Banking Risk
Welcome to The Sunday Morning Post. Each week I wrote about the economy, real estate, and occasionally other topics. Thank you to everyone who is subscribed and who reads each week. I appreciate you being here.
In the American classic film It’s a Wonderful Life, protagonist banker George Bailey heads off a bank run by appealing to his customers who were demanding withdrawal of their funds by saying, “We can get through this thing all right. We’ve got to stick together though. We’ve got to have faith in each other!” As George Bailey tells the people of Bedford Falls, their money does not simply sit in the bank’s vault: it has been lent out to other customers for them to buy homes and for other personal borrowing, and that all the money will come back to the depositors with interest paid, but it is not immediately available if all customers want to withdraw their money at the same time. George Bailey even tells one customer he would have to wait 60 days to get his funds.
If not oversimplified and Hollywood-ized, to a certain degree this one iconic scene defines our collective understanding of what a bank run looks like: customers get spooked that they will lose their deposits because of the real or perceived risks that their bank might fail, and as they rush to withdraw their funds it perpetuates further withdrawals as the perception (and reality) of the situation snowballs and more and more people start to panic that they will lose their money.
To help prevent this from happening, the FDIC was established in 1933, guaranteeing up to $2,500 of depositors’ fund. This amount has been increased several times over time due to both inflation and the desired goal of having customers feel more secure in their deposits, which provides stability to the overall banking system. Today’s insured amount per depositor is $250,000 and there is talk in the wake of the SVB collapse of increasing that to $500,000 or even $1,000,000.
The creation of the FDIC and other banking regulations born out of the Great Depression and beyond have largely succeeded in preventing bank runs. In fact, most younger Americans today probably cannot even conceive of a true bank run as runs today are so infrequent. Plus most people think that one of the primary purposes of a bank is to simply be a safe place to keep their money; they do not think of banks as dynamic and complex entities that are working to earn income at the margin of what they pay to get deposits compared to what they earn back from lending those deposits out. That these deposits might not actually be there to give back to the customers whose name they are in is simply inconceivable to most people.
Bank Runs Today
But bank runs do still happen, including just earlier this year with regard to Silicon Valley Bank (SVB) and several other banks that either failed or were on the precipice of collapse. With regard to SVB, on Wednesday, March 8th, the bank announced that it was having liquidity issues and that it would be doing a new stock issue and selling bonds (at a loss) to generate cash. This understandably spooked customers, who proceeded to pull funds out of SVB in droves. As rumors of a bank failure escalated, the run was on.
What is different today than in previous times is how quickly funds can be moved. You don’t need to walk into a bank lobby anymore and request a withdrawal check or actual bills and coins; a new account can be opened at a different bank in a matter of minutes and funds can be transferred virtually instantaneously. In It’s a Wonderful Life, an elderly gentleman angrily tells George Bailey he has $242 in the bank and he wants it now. On Thursday, March 9th, SVB customers withdrew $42 billion. On Friday, March 10th, another $100 billion would have gone out the door if the Fed had not stepped in to seize the bank’s assets. In fact it was notable that the FDIC closed SVB Friday morning as opposed to letting the business day play out, which is often their practice when seizing a bank. It was evident by the early morning hours, however, that SVB would not even survive the day. The combined $142 billion represented 81% of the bank’s entire deposit base. Although $242 was more money in the time of the movie, it wasn’t $142 billion.
The other major variable that makes bank runs different today (and potentially much more perilous) is the ubiquitous nature of social media. Bank runs can be triggered by liquidity issues, concerns about management practices, or any one of a number of other variables, but the wind that fans the flames is rumors. Once word starts to spread that a bank may be in danger, staving off those rumors can be like trying to put rain back into a cloud as the story is spread like wildfire through posts, re-tweets, and other social media chatter.
The post mortem of 2023’s bank collapses and in particular SVB points to social media as a key variable. In fact, a Fed report from this past April said, “Social media enabled depositors to instantly spread concerns about a bank run, and technology enabled immediate withdrawals of funding.”
What Comes Next
Fed officials and other banking regulators will have to significantly re-think the way they operates in this new modern world. So, too, will CEOs. While George Bailey talked to his customers directly in the bank lobby, the Silicon Valley Bank CEO, in fact, chose not to take questions on an earnings call just prior to the company’s collapse. And even the statements the company did put out did more harm than good by being both simultaneously vague and inflammatory.
The aforementioned Fed report also does not mention one thing I think is a key variable and poses acute risk to publicly traded banks, which is the online armies of Redditors (i.e. online message board posters), Twitter users, and more who can drive stock prices up or down with a series of posts, clicks, and shares. Consider what happened with Gamestop and AMC stock prices and many others throughout much of 2021. These companies’ stock prices saw massively unexpected fluctuations thanks in large part to social media-field hysteria. There are dozens of banks that are publicly traded that could be subject to the same online frenzy. Regulating such risk will take thoughtfulness, nuance, and an awareness and appreciation for the power of social media that, I fear, current bank regulators not to mention many elected politicians in Congress and elsewhere simply do not have.
It should be noted as clearly and specifically as possible that the current state of the banking economy is stable if not without numerous risks, only some of which I’ve articulated here today. But all twenty-three of the banks on which the Fed just recently performed its annual stress tests passed and are projected to be able to weather the storm if the United States were to fall into a severe recession. A deep recession is not imminently projected by any means, but the passing of the stress tests is at least a good sign (although the risk to brick and mortar banks of Fintech and online banking is, I believe, under-studied and perhaps a topic for a future article here in the pages of The Sunday Morning Post).
I have never witnessed a bank run and I don’t expect to. Warren Buffett said recently he would bet $1 million that no single American depositor would experience losses this year and I am in complete agreement (plus who would I be to disagree with Warren Buffet). As a banker, the closest thing I have ever seen to bank-run behavior is probably in the early days of the PPP program, when there was a chance that the generous benefits program for businesses was going to run out of funds. There were several days when I would arrive at the bank early in the morning and find customers waiting at our door (actually, standing in our drive thru because the bank lobby was closed at this time due to COVID). These customers were waiting to fill out their PPP applications so that they could be submitted before the program ran out of money (PPP applications had to be submitted through a bank; hence why they were in our drive-thru). That crazy period of time, too, is also worth a future article.
Ben Sprague lives and works in Bangor, Maine as a Senior V.P./Commercial Lending Officer for Damariscotta-based First National Bank. He previously worked as an investment advisor and graduated from Harvard University in 2006. © Ben Sprague 2023.
I did not have time to put together the weekly round-up this week because I am in New York this weekend (well, technically at the moment I am at a hotel in Great Barrington, Massachusetts) with my son for the Region 1 (New England + New York) Junior Olympic Track Championships. My son ran on Saturday and set a personal best in the 400m and will run again on Sunday in the 800m. I am very proud of his effort and we are having a nice father-son weekend. See you next week, everybody!
