09 October 2024

CEPR: Addressing banks’ vulnerability to runs, part 1: Facts, arguments, and policy challenges

by Beck, Ioannidou, Perotti, Sánchez, Suarez, Vives:The bank failures in March 2023 revived old debates about the role of deposit funding for banks, how to address the fragility of deposit funding, and general policy reflections on the need to adjust banks’ regulatory and supervisory frameworks.

This first in a two-column series discusses the role of deposit funding in the EU banking system and the related risk of runs. It then elaborates on interest rate risk in banking and identifies existing or potential policies that could be used or adapted to address the vulnerability to runs or its underlying causes. 

The banking turmoil in March 2023 was a stark reminder of the fragility associated with banks’ funding structures, especially when they rely on an inadequately diverse uninsured deposit base (Basel Committee on Banking Supervision 2023, Board of Governors of the Federal Reserve System 2023, Swiss Financial Market Supervisory Authority 2023, Admati et al. 2023, Honohan 2023). These cases provided new evidence of the speed at which, in a world of digital banking and social networks enabling the rapid flow of information, adverse news on a bank’s solvency or liquidity position can put it on the brink of failure in a matter of weeks, if not days or even hours. A few days after the Silicon Valley Bank and Signature Bank failures, the forced merger of Credit Suisse with UBS showed how the legacy and viability problems of a larger bank, if left unresolved for a long period, may also crystallise in the need for a sudden intervention by the authorities when investor confidence breaks down, deposits are withdrawn on a massive scale, and access to market funding is lost.

To illustrate the vulnerability of banks to runs, Figure 1 simulates the implications for the EU banking system of deposit withdrawals with the speed and intensity of those seen in specific run episodes. For each selected case, each panel shows as a function of the number of days into a run episode, which share of total assets of the EU banking system would stay at banks able to withstand the deposit withdrawals with their available liquidity (cash, central bank deposits, and demand deposits) and without access to any refinancing. Despite its stark assumptions, this hypothetical simulation shows that, in the absence of external liquidity support, a large part of the EU banking system would be able to cope with deposit outflows like those witnessed during the global crisis (e.g. Northern Rock in 2007), but only a very small proportion would be able to withstand runs like those at Silicon Valley Bank or First Republic....

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