Enlightenment of Bank Run Crisis in the United States

  After the epidemic, the Federal Reserve released a lot of water, which led to a flood of liquidity. Silicon Valley Bank, which mainly serves technology companies, has seen a sharp increase in deposits of more than 110 billion US dollars. Due to limited credit channels, Silicon Valley Bank has allocated a large amount of bonds (Treasury bonds, MBS, etc.), resulting in duration mismatch and interest rate risk mismatch.
  Since 2022, the Federal Reserve has raised interest rates sharply, and the yield of U.S. bonds has risen sharply. The bond assets held by Silicon Valley Bank have suffered serious “floating losses”. According to media reports, if all the floating losses are realized, shareholders’ rights will face the risk of being cleared.
  In 2022, affected by the Federal Reserve’s interest rate hike and the financing slump in the technology industry, Silicon Valley bank deposits will continue to decrease, bringing liquidity pressure. Although the company has increased short-term loans of more than 10 billion US dollars, it still cannot meet liquidity needs. In March, the company was preparing to sell 21 billion bonds. The transaction would result in a real loss of 1.8 billion. The market interpreted this as a liquidity problem in the bank, and a run on the bank followed. %, Silicon Valley Bank declared bankruptcy 2 days later.
The spread of the run

  After the collapse of Silicon Valley Bank, although the Federal Reserve acted quickly to provide liquidity support to the banking system, the US government provided deposit insurance to depositors. But soon, the Signature Bank (Signature Bank), which was closely related to the “currency circle”, went bankrupt, and the First Republic Bank and Charles Schwab Bank also suffered runs. Systemically important banks in the United States were also affected. Big banks such as Bank of America and U.S. Bank were also suspected of having large floating losses in bond investment, and their stock prices fell sharply.
  The crisis is spreading to Europe. Credit Suisse Bank, the second largest bank in Switzerland, has been operating poorly for many years, and the Silicon Valley Bank incident caused panic. Credit Suisse Bank’s stocks and bonds plummeted. The Swiss National Bank promised to provide liquidity support to avoid further spread of the crisis.
  The current banking run crisis is still brewing. If the run cannot be controlled, a greater banking crisis may be triggered, which will inevitably lead to credit contraction and increase the risk of economic recession. The Fed faces a dilemma between controlling inflation and stabilizing finance. Taking into account the fragility of the banking system, credit contraction and the risk of economic recession, the market expects the Fed to start cutting interest rates as soon as June.

  Reversing the cycle is a beautiful wish, but it is very difficult to implement in practice. Which bank doesn’t want more and more customers and bigger and bigger business? But in fact, what will kill Silicon Valley Bank is the sharp expansion of deposits in 2020-2021. Doing a good job in asset and liability management, doing a good job in interest rate risk control, keeping in mind the concepts of “economic cycle” and “currency cycle” in operating principles and subconsciousness, doing a good job in cross-cycle management, and relaxing annual profit assessment are crucial to the long-term development of financial companies. No matter how good the business was in the past, once a major business error occurs, it can be said to be “sick as a mountain” after the risk is exposed, and it may only take a few days to go bankrupt.
  We used to think that deposits are “good” liabilities, and interbank liabilities are unstable and easy to magnify interbank shocks, which are “bad” liabilities. However, this round of run crisis shows that this understanding may be correct in most cases, and in some cases it is Incorrect.
  We hope to reduce financial risks by strengthening supervision. In fact, supervision can only deal with high-probability events and has no defense against tail risks. The same is true for the pricing of financial products. In order to completely avoid a run on the bank, the leverage of the bank needs to be reduced enough. Once the leverage is reduced, the bank’s shareholder return (ROE) will drop sharply. Either no one will invest in the bank, or the price of bank services will become very high. This is obviously the real economy. unbearable. We always need to find a balance between general safety and tail risk, which means that tail risk always exists.

  This round of bank runs started with Silicon Valley Bank, but why was First Republic Bank also run on? The bank’s asset scale is comparable to that of Silicon Valley Bank, but its asset structure is completely different. 80% of First Republic Bank’s assets are loans, and it is mainly housing mortgage loans. The asset quality is very good, and there is no problem of huge floating losses on bonds. Why run on it?
  There is a view that First Republic Bank’s net interest margin has narrowed, and its operations are under pressure. Which bank does not have this problem in the early stage of interest rate hikes? First Republic Bank ranks in the top 20 in the United States. Shouldn’t those small banks be more run on? Some people say that First Republic Bank’s proportion of uninsured deposits is too high, so Citibank’s proportion is even higher. Why not run on Citigroup? As for the issue of bond floating losses, some analysts have calculated that Bank of America (an important bank in the global system) and U.S. Bank of America have a high ratio of floating losses to net assets. Should they also be run on?
  The problem of bank runs is often reasonable at the beginning, but the subsequent spread of contagion will become more and more irrational, and this is precisely the typical feature of a crisis. For the further fermentation of this round of run crisis, it is necessary to hold an open view instead of restricting thinking and vision from rationality.
  In fact, regarding the run on First Republic Bank, I personally think that the reason may be that it has a high degree of overlap with Silicon Valley Bank’s business area and customer base. Therefore, the overlapping of customer groups is another important mechanism of contagion.
Reflections on Economic Theory

  Modern Monetary Theory (MMT) has been all the rage in recent years, and I used to agree. As long as there is no inflationary pressure, national debt can be issued at will (internal), and finance can be monetized. However, this round of banking crisis shows that the assumption of “no inflation” is problematic. Inflation cannot be assumed to always remain low. Once inflation takes off and monetary policy changes from extremely loose to fast tightening, trouble will come. The system bears the brunt, and the erosion of net capital by bond floating losses is a typical problem. Monetary policy changes from loose to tight, and bank liabilities increase to decrease. This process will generate liquidity pressure (or balance sheet shrinkage pressure), forcing floating losses into real losses, and accelerating the exposure of bank problems.
  This round of bank run crisis has once again reiterated that finance is not a veil and currency is not neutral—this is the conclusion of the subprime mortgage crisis, but people have become accustomed to zero interest rates and low inflation in the past ten years. The crisis is another reminder of economic theory.

  The academic circles have actually done sufficient research on the bank run crisis. The 2022 Nobel Prize in Economics is awarded to Ben Bernanke, Douglas Diamond and Philip Dibwig, the latter two famous for their research on bank runs, and their conclusion that deposit insurance is essential to prevent them. But in this crisis, I feel that deposit insurance is not enough, not just the amount of coverage (the US upper limit is 250,000 US dollars, China is 500,000 yuan), but more importantly, the changing times.
Crowd behavior in the age of Twitter

  What is the difference between the era we are living in today and that of one hundred or forty years ago?
  A hundred years ago, bank runs in the United States were very common. If you want to bring down a bank, you only need to send people to deposit a large amount of money first, and then go to collect the money after a while. If the bank is out of cash, there will be a long queue outside Then they yelled on the street, “This bank has no money, and the deposits cannot be withdrawn”, and the run came immediately.
  Forty years ago, the situation was basically similar, except that people got more consumption from TV and newspapers. Although information spread faster, most withdrawals were still in queues, and the run on efficiency was relatively low.

  The information age may also allow noise to flow more unimpeded, and herding behavior to become more rapid and focused.

  Now, things are very different. On the one hand, transfers are now performed on mobile phones or computers, and the transfer can be completed in one minute, which is too convenient and the cost of running on the bank is too low; on the other hand, the ability to disseminate information has been fully upgraded. Some people say that this is the information age, but I prefer to call it the “Twitter age”. A U.S. congressman said that this round of run was the first Twitter-driven bank run in history. Whether it’s Twitter, Facebook, Weibo, Baidu Hot Search or other information apps, they all speed up the dissemination of news. Whether it’s the speed or scope of dissemination, it’s almost comprehensive and synchronized. There will be a stronger sense of substitution. These changes in the dissemination of information clearly changed people’s behavior and amplified their impact.
Figure 3: Deposit Insurance Coverage of Major US Banks

  We assume such a scenario: after the Silicon Valley Bank incident, someone maliciously shorted a bank stock, and the stock fell by 10% at the opening. , but in fact there may not have been a run on the bank, it was just being shorted. When ordinary people saw this news on their mobile phones, what was their first reaction? Is it to find out the company’s financial report and study whether it will be run? no. Most people would rather believe it, and open the mobile banking APP, enter the password to transfer the deposit. If many people do this, the news may break out at noon that “the bank of such and such has suffered a run, and the transfer order cannot be executed.” Let’s look back at this process. Can deposit insurance give depositors peace of mind? I’m afraid not. Even if there is no loss of deposits, once the bank goes wrong, it may affect normal payments and transfers, so why keep money in it? After all, it only takes dozens of seconds to move your fingers to transfer the deposit.
  The times we live in have changed significantly. This change may not necessarily make information more effective, but it may also allow noise to flow more unimpeded, and herding behavior has become more rapid and concentrated. The “Information Age” (“Twitter Age”) does not necessarily make society wiser and calmer, but may intensify social fluctuations. This is worthy of reflection and long-term attention.

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