The Only Way to Stop Bank Runs Is to Get Rid of Banks

The failures of Silicon Valley Bank, Credit Suisse Group AG and others have gotten financial authorities thinking again about bank runs and liquidity regulations — and whether some rules ought to be tweaked to make the system safer.

Mostly, though, the debate misses the point. The only way to guarantee an end to bank runs is to get rid of banks. That isn’t as flippant as it sounds: It has been one of the ideas often proposed since the 2008 financial crisis, under the name of narrow banking. It’s a idea I don’t buy, as I’ll explain.

But first, the liquidity rules. Liquidity coverage ratios are meant to ensure a bank has enough cash-like assets to cover a drain on its funding in a stressed situation over a period of 30 days. It involves estimating outflows from depositors, lenders, borrowers and counterparties to derivatives trades among other things. The cash-like assets a bank holds are the “fractional reserve” in the classic understanding of banks, as the financial blogger Frances Coppola put it in a smart definition recently.

For example, under the international Basel standards, a bank must be able to pay out at least 3% of retail deposits if they are fully insured, that insurance is credible and the deposits are in accounts linked with other services or where salaries are paid. These conditions are not easy to meet entirely and in practice the lowest assumed outflow rates are 10%. For rich clients with large deposits, the minimum is higher and for large corporates it’s at least 40%, again with conditions attached.

Different countries’ regulators often impose higher outflow expectations than these minimums. Maybe they could lift them a touch further, but this is all shifting proverbial deckchairs. Liquidity rules only protect banks against fluctuations in customers’ needs for liquidity caused by economic or financial stresses outside a bank. Bank runs are totally different beasts: A run is a panic that — whether or not it had a rational cause — will almost certainly be ruinous. And typically happens much faster than 30 days!