The Digital Age of Bank Runs

Aldous Huxley wrote that ‘the charm of history and its enigmatic lesson consist in the fact that, from age to age, nothing changes and yet everything is completely different‘.

Banking institutions stand as a symbolic and structural linchpin in economic stability. When things look uncertain in financial markets, fear and panic can take hold of depositers.

Banking runs are as old as banking itself. The fear of financial instability or rumour has driven unconnected groups in the past to withdraw en masse.

Banks have faced and fended off waves of crises in the past. But now they have to deal with ones from inside and outside their walls.

Australian banks have not experienced a bank run in decades and appear in good health.

But US officials had made similar promises before the US bank run in March this year, which impacted regional banks. The largest was the now-infamous Silicon Valley Bank (SVB).

I’m not here to suggest a bank run will happen in Australia anytime soon, but instead, look at what has changed in our new digital world.

New Risks on the Horizon

The Australian financial system is not immune to global trends where digital advancements and external pressures reshape the landscape of risk and resilience.

These challenges include everything from large cyber attacks, rapid deposit shifts, and world events that race across our screens.

Brad Jones, assistant RBA governor, warned about the digital age in a speech recently, saying:

‘The emerging risks we are likely to confront over the next decade have a different complexion to those of recent decades.’

The financial sector faces a double-edged sword. Depositors and banks seek and push innovations. In the last PwC banking survey, 69% of responders agreed with the statement that when it comes to choosing a bank for a financial product or service, ‘having the most up-to-date technology is important’.

But with each new technology comes Pandora’s box. The next 10 years will bring risks we haven’t seen before, and old ones with new faces.

In an interconnected world, the ability for a tweet or a sudden outage — like the one experienced by Optus users last week — can set off chain reactions that are hard to predict.

But as Nassim Taleb said in his brilliant book on unexpected events, Black Swan:

‘The inability to predict outliers implies the inability to predict the course of history.‘

So, if I’m going to make a prediction, then it’s one where these events become more likely.

Within the banking world, the velocity of money has increased to the stroke of a keyboard, and news travels in hours rather than days.

From the outside, big global politics, mistakes in how banks run their systems, and environmental changes are new challenges without a playbook.

Bank Run 2.0

In banking, concerns about rapid outflows enabled by technology have been growing since the crisis at Continental Illinois in 1984.

The bank, an early adopter of new systems, allowed rapid cash transfers to corporate clients. After weeks of rumours that included the first coined use of the phrase ‘too big to fail‘— the bank did exactly that.

Over the next 10 days, the bank lost approximately 30% of its funding or US$10 billion. That’s just shy of US$30 billion today, adjusting for inflation.

Rumours around a bank’s insolvency built up for months or weeks in the past before it led to runs. The collapse of regional banks in March showed a modern timeline.

The biggest bank of the group, SVB, held around US$209 billion…making it the second-largest bank failure in US history.

The largest, Washington Mutual, failed in 2008 and crumbled over eight months. SVB’s collapse took scarcely two days.

The reasons for SVB’s demise aren’t covered here, but this simply explains why it failed.

What began as dark clouds on social media on 8 March turned into a storm. Michael Imerman, professor at the Paul Merage School of Business, says what happened to SVB was ‘a bank sprint, not a bank run, and social media played a central role in that’.

After an I’ll timed capital raise, the rumour mill began. Tweets from depositors began circulating. A widely circulated tweet by Mark Tluszcz, CEO of Mangrove Capital, warned:

‘If you are not advising your companies to get the cash out, then you are not doing your job as a board member or as a shareholder.’

SVB customers panicked and withdrew US$42 billion from the bank on 9 March. But that paled to the next day when customers attempted to withdraw US$100 billion. The total figure represented over 80% of the bank’s deposits.

In the aftermath, Daniel Davies, managing director of Frontline Analysts, summed up the experience, saying:

‘If you see a bomb disposal expert running down the street, don’t ask them what’s happened, just try to keep up.’

The bank had no hope of meeting its shortfall and shut its doors. As assistant RBA governor, Brad Jones remarked in his speech about Australian banks:

‘In our current system, any bank would struggle to survive a run of this magnitude.’

The dizzying pace at which money flew out the door shows how quickly bank runs can happen in a new social media age. This information rush is abetted by the speed of bank transactions in the modern financial system.

Banking in Australia Today

Australian banks have been doing well compared to their overseas counterparts. They’ve been careful and have robust rules compared to international standards.

The Australian banks hold more capital than 75% of their international peers and have a small percentage of loans that are in default, known as Non-performing assets.

In the latest stress tests conducted by regulator APRA, the watchdog said that depositor funds would be safe even if the economy declined by 4%, unemployment rose to 11%, house prices fell by over 40%, and then every bank was hit by a cyber-attack.

However, even Australian banks know they can’t just sit back. Events like SVB challenge our conventional safeguards and should prompt another look at regulations to bolster resilience against these swift digital age phenomena.

APRA has recommended ‘further strengthening liquidity and risk management frameworks‘ in response to the evolving digital landscape. What this means beyond banks simply holding more cash on their books is vague and needs a better look.

For everyday Australians, little love is lost if banks fail. But for your own security, it’s essential to know the full details of the government deposit guarantee and ensure all your eggs aren’t in one basket.

Australia’s financial sector, while currently stable, must not underestimate the transformative impact of digitalisation and the uncertainties it brings.

A big factor in this is the cybersecurity realm, something we will cover in full next week.

The task ahead is to anticipate, adapt, and act to ensure that the digital age of banking remains a tale of innovation rather than instability.

Regards,

Charlie Ormond,
Editor, Fat Tail Daily