Mar 28, 2024 - Business

Here's how to prevent the next bank run, according to former Fed officials

Illustration of Benjamin Franklin hiding behind a Roman column.

Illustration: Lindsey Bailey/Axios

One year after a massive bank run led to Silicon Valley Bank's failure, top banking scholars have ideas for how to contain the risks of a new era in which customers can yank deposits with a tap on their phone.

Why it matters: Last year's regional bank failures showed how quickly customers can pull funds in response to fast-moving information, a key cause of the collapses of SVB and First Republic Bank.

  • The group says that without new rules, the huge shifts in banking trends in the last quarter-century make such episodes a bigger threat to the financial system.

What they're saying: Booming growth of uninsured deposits paired with the rise of technology and social media "have made bank runs more rapid and violent than ever before," six Harvard professors write in a new paper being presented Friday at the Brookings Papers on Economic Activity.

  • It "lends urgency to the question of how such extreme run risk can best be mitigated going forward," write the authors, who include former Fed governors Dan Tarullo and Jeremy Stein.

The intrigue: The authors suggest that deposit insurance should be expanded beyond the current $250,000 limit — a possibility discussed by lawmakers in the aftermath of last year's crisis that ultimately hit a wall.

More novel, perhaps, is an idea that would require banks with more than $100 billion in assets to back uninsured deposits with collateral consisting of short-term assets at the Fed.

  • That would essentially allow for backup funds in stress periods that could help a bank withstand a run.
  • The authors don't elaborate on exactly how this collateral requirement would work — for example, whether it would need to be dollar-for-dollar relative to deposits. They also warn the requirement should be structured "so as to not overly constrict bank lending."

The big picture: "The main force of our proposal is to drive longer-duration securities holdings out of the banking system when they are being funded by uninsured deposits," Stein said in a briefing with reporters Tuesday.

The authors' research shows a "combustible mix" is becoming more common across the banking system.

  • There's a rising share of uninsured deposits — and more banks are investing those funds in longer-term securities that are ultra-safe but fluctuate in value when there are big shifts in interest rate policy.
  • Banks with the fastest surge in deposits in recent years (particularly uninsured funds) have seen the lending of those funds drop, while their holdings of securities have jumped: "Banks are awash in deposits, but their lending opportunities have gone down," Stein said.

By the numbers: This trend marks a drastic shift from recent decades, the authors find. In 1995, uninsured deposits made up 20% of all domestic deposits; now, it's nearly 40%.

  • Meanwhile, larger banks have seen cash and securities go from 24% of their assets in 2000 to almost 40% in 2023, the authors say.

Where it stands: Tarullo, who shaped post-financial crisis bank regulations while at the Fed, said one big irony was the slate of tougher bank capital proposals that came out months after the bank failures.

  • The proposals, known as Basel Endgame, "were not especially responsive to those failures," Tarullo said. "I think there's probably a more widespread recognition that something really does need to be done here."

What to watch: The authors also argue regulators should be more open to mergers of mid-sized banks that lack the economies of scale to compete with the large ones.

  • This is a topic that puts financial regulators — who seek a more sound financial system — at odds with the Biden administration's competition policy, which is skeptical of big companies getting bigger.

The bottom line: Tarullo said that the authors have shared a draft of their proposals with some regulators.

  • How did they respond? Tarullo declined to say specifically, but he quipped: "Thinking about how I would have acted if somebody had sent a really interesting draft to me, I would have said 'Gee, that's quite interesting' and moved on."
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