Mobile Bank Run
The following piece concerns bank runs in the digital age, which exhibit some novel characteristics unknown from traditional bank runs. The case that a new kind of bank run exists is made by looking at the elements of the Silicon Valley Bank default. The bank technically witnessed a classic bank run. But an interesting one: the first truly mobile bank run. I will call this novel mobile phenomenon Tapping on the bank.
Others have written broadly on bank runs and the traditional aspects of the case in question. Here are some pieces from the Economist, the Financial Times and Matt Levin:
https://www.economist.com/finance-and-economics/2023/03/13/americas-government-steps-in-to-protect-depositors-at-silicon-valley-bank
https://www.economist.com/leaders/2023/03/13/what-really-went-wrong-at-silicon-valley-bank
https://www.ft.com/content/56a8df6b-3466-4524-9f02-16bc3276c580
https://www.bloomberg.com/opinion/articles/2023-03-13/svb-couldn-t-ignore-its-losses-but-the-fed-can
It is worth iterating briefly that a bank run is always driven by emotion as it is caused by rationality. Bank runs are triggered by expectations from depositors that not all can get their money or parts of it back. Here is a more formal description from last year’s Nobel Prize Winners, Diamond and Dybvig: “During a bank run, depositors rush to withdraw their deposits because they expect the bank to fail. In fact, the sudden withdrawals can force the bank to liquidate many of its assets at a loss and to fail.”
To ensure they are not the last ones to demand their money back, everyone rushes to the bank and tries to get their money first. Hence, a run on the bank, since you would supposedly run to the bank as fast as you can to overtake your fellow depositors on the way. At least, that is how it worked in the past. Today you would instead press a few buttons on your smartphone to withdraw. You try to tap faster than the other depositors. In 2023, people are tapping on their banks. We just witnessed the first mobile bank run in the US Banking system.
But let’s investigate what differentiates a mobile tap on the bank from the traditional physical run on the bank by looking at the events around Silicon Valley Bank.
First, a tap on the bank is swift. This attribute stems directly from the digital nature of banking today. Digital inertia for action is much lower than physical inertia to do something. The same is valid for taking deposits from the bank. I believe people might have reacted differently if everyone had run on the bank in person. First, people are busy. Not everyone has time to visit a branch of SVB on a Thursday. Physical actions need more conviction than the casual pressing of buttons on the phone. And imagine all the VC and Start-Up founders meeting in front of the Palo Alto SV branch. They might even have devised a strategy like: ‘Why do we not withdraw all our money at the same time? That might save the bank, and we save us the trouble of killing our industry-specific bank’.
Anyways, a few taps on the smartphone and the deposits were withdrawn. This led to a staggering flight of money of 42 billion USD on Thursday alone. 42 Billion of roughly 200 billion in one day. These numbers do not work in the fractionalised reserve banking system.
Let’s iterate the characteristics of a mobile bank run or bank tap. Tapping on the bank is much faster than the traditional running on the bank because of its digital nature and the minimal inertia innate to online actionism.
Second, information flows much more rapidly in the mobile age. Even in 2008, information contagion was slow compared to today. Social media and on-demand streaming of information make it possible to get live information on any event. In normal circumstances, this might be a valuable thing, but in times of crisis, humans tend to overdramatise the situation, it is bad. It is just a natural tendency to be cautious. For the banking system, the speed of information is a severe problem. Regulators need to adapt as fast as information spread. This is quite difficult, as events have proven.
Third, online forum communication leads to groupthink and herd behaviour. Silicon Valley, one might argue, is a large information silo. An echo chamber tightly connected through personal ties and their Twitter feeds. As in any echo chamber, exuberance and panic are two sides of the same coin. Silicon Valley feeds from its tight network, but it can also be counterproductive in times of crisis. “It turned out that one of the biggest risks to our business model was catering to a very tightly knit group of investors who exhibit herd-like mentalities,” SVB executive in the Financial Times. This might be the most interesting and staggering part of the events. If Silicon Valley had worked together, everything would have been ok, instead of collaborating on Twitter to Tap on the bank. Everyone could have said: “Ok, we know the balance sheet is not perfect[1], but we understand enough of Banking to know that it is mostly a maturity mismatch between assets and liabilities. We could withdraw our money, but that would only lead to a Tap on the bank, so we coordinated to stay calm instead. We also notice the Silicon Valley Bank has already started to issue new equity to improve the situation. We should talk to regulators to ensure they are aware and SVB gets supervised.”[2] But obviously, this is not what happened. But it shows that more careful communication, instead of fear, might have helped.
Fourth, we live in a world of experts. When a world-shattering event happens, everyone becomes an expert in the area. As Twitter was overpopulated by PhDs in medicine and biology during the pandemic, now everyone is an expert on banking in Finance. This disease seems to be especially widespread in Silicon Valley Land. One tended to remind some VCs, Entrepreneurs, or Angel Investors that living in Silicon Valley land does not make them experts outside their expertise, whatever that might be.
To summarise, a tap on the bank happens fast. It is driven by fear initiated on online platforms. Contagion is instituted by a herd of experts on social media who form their opinion in online echo chambers. Meanwhile, the tapping on the bank starts. The reinforcement leads to a reflective cycle—more fear through faster extreme information spread online. The tapping becomes more and more and more with every reflexive cycle. The process breaks when the bank can no longer pay out the deposits, and the government must come to the rescue. The base pattern is similar to that of a traditional bank run, but the nuances are different, and the speed with which the events happen makes it a dangerous threat to the modern banking system.
What does the first tap on the bank mean for the banking system? Banks and regulators need to adapt. We likely need to rethink our approach to capital requirements and banking regulation. If customers can pull a quarter of the bank’s total assets in half a day, it is not enough to have capital requirements of 10%. This is especially true if banks sit on unrealised losses. Jeffrey D. Gordon, in his piece “Financial Institution Innovation Needed in Silicon Valley”, suggests two measures: “(1) deposit commitments with a penalty for early withdrawal and (2) mutual stock ownership by depositors that zeros out upon early deposit withdrawal”. A discussion of possible new regulations warrants an own essay. But one can conclude that non-mobile banking regulation does not work in the mobile age. Regulators must keep up with technological change, especially in the financial sector. The repercussions will be felt throughout the real economy if they cannot. The problem lies deeper than financial or banking regulation. It is fundamentally the race between technological innovation and regulation. Silicon Valley bank was only the first example. It would be foolish to believe it will be the last.