The 1946 film “It’s a Wonderful Life” features the classic depiction of a bank run. Depositors storm the fictional Bailey Savings & Loan and line up to pull out their money, ratcheting up the tension as George Bailey tries to convince them — one-by-one — that the institution is viable.
In today’s world of digital deposits, it’s not surprising that George Bailey’s method for stopping a bank run is no longer possible. But the failures of Silicon Valley Bank, Signature Bank, and First Republic Bank earlier this year showed us that bank runs can happen faster than George Bailey might have ever possibly imagined.
In previous decades, bank runs weren’t as common — and that’s partly because they were slower. Up until recently, depositors had to physically run to the bank. That gave bankers more time to call a bank holiday, re-establish confidence or seek new funds from a larger bank to stabilize deposits.
Under these conditions, bank failures were infrequent and tended to happen in waves — between 1941 and 1979, an average of 5.3 banks failed each year. According to Pew, the SVB and Signature failures were the first in more than two years. Yet, the magnitude of this year’s three bank failures surpassed the 25 that occurred during the global financial crisis in 2008.
In the digital age, a bank failure can happen in an instant. According to Axios, in one day, Silicon Valley Bank’s customers withdrew $42 billion over 10 hours — an average of $4.2 billion an hour, $1 million per second, for 10 hours straight. To protect depositors, the Fed needs to recognize and address three ways in which the digital economy creates warp-speed bank runs.
“ Bank runs are always a mass psychology event.”
First, modern information sharing can coordinate beliefs in a way that sets off a chain reaction. Bank runs are always a mass psychology event: if everyone else thinks they should withdraw their funds, an individual depositor feels compelled to do the same.
More interconnected communication brings more coordinated changes in beliefs among groups of connected people. The digital economy has provided us with unprecedented means to synchronize our psychology. For example, panic to withdraw funds from SVB reportedly started among venture-capital leaders in private messages on WhatsApp, email chains, texts, and other closed forums.
Worse yet, the trigger could be fake news. Social media has made it effortless to spread unverified rumors. Society is becoming accustomed to receiving news from people who may not check their facts, and the results for banks could be disastrous. Regulators and watchdog groups must proactively monitor and counter misinformation before it spreads and prompts real-world actions.
“ The rapid spread of bank-run news is dangerous because it accelerates a bank run. ”
Second, the digital economy has accelerated communication. The days of sharing information in a letter, conversation, or report have been replaced by tweets or posts that can be shared instantly and globally. While speedy personal communication is convenient, the rapid spread of bank-run news is dangerous because it accelerates a bank run. Banks are now recognizing social media as a potential threat and are implementing emergency procedures to address it.
Finally, the speed of financial transactions is an accelerant. In the digital economy, bank accounts can be opened or closed at incredible speeds. The FDIC reports mobile banking among banked households nearly tripled to 43.5 percent in 2021 from 15.1 percent in 2017 and remains the primary method of account access. My colleagues Tano Santos, Naz Koont, and Luigi Zingales find that digital banking undermines financial stability. When interest rates rise and keeping money in a low-interest account becomes costly, clients of traditional banks stick with their deposits. However, clients of banks with digital platforms are far more likely to withdraw their funds. When such a withdrawal happens in a rapid and coordinated fashion, that is a bank run.
The Federal Reserve must provide financial protections that can effectively respond to the size and pace of digital bank runs. Fed Chair Jerome Powell recognizes the Fed has to be ready: “There is a need for possible regulatory and supervisory changes because supervision and regulation need to keep up with what’s happening.”
To address the new challenges, the Federal Reserve needs to speed up its reactions, slow down transactions and constantly monitor online communication. Stock markets use automated circuit breakers to pause trading when it poses potential risks. The Fed also needs automated tools: meetings and human decision-making cannot keep pace with the speed of communications and transactions.
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At the same time, extending waiting periods for large withdrawals could lessen the pressure to run first, before the money runs out. While flexibility, discretion and on-demand funds are convenient, we cannot compromise our banking system when the technology is available to stop a financial crisis before it becomes a complete fallout.
Laura Veldkamp is a professor of finance at Columbia Business School and a former editor of the Journal of Economic Theory.
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