The Modern Bank Run

How the velocity of bank runs has changed in recent years and what it means for investors.

There have been several high profile bank failures in the last couple of weeks that are causing international economic fallout. One startling quality common among the failures has been the velocity of the asset departure from the affected banks. Let’s review some bank run history, look at what happened to Silicon Valley Bank as an example, and think about why this matters and what can be done to mitigate risk going forward.

What does a historical run on the bank look like and how did we get here?

Before the age of the internet, a typical run on the bank took place at a physical bank location where depositors clambered to make their way to the bank window to demand their dollars. This type of event was typically precipitated by fear that the bank could be insolvent or unable to meet all of its financial obligations. Rumors that the bank may not have enough cash on hand to service withdrawal requests would create panic as depositors rushed to redeem their funds. In some cases, the bank could scramble and borrow money from other financial entities to cover claims on deposits, or the bank could sell assets on their balance sheet to raise cash. In other cases, the bank would fail and depositors would not be made whole.

As a result of frequent bank runs in the early 20th century, US legislators felt it necessary to provide legal structure and recourse for depositors. The Federal Depository Trust Corporation (FDIC) was created in 1933 to insure deposits up to a certain amount, mandate reserve requirements, and standardize bank reporting.

Many years later, after the great financial crisis, further regulations were written into law in the form of the Dodd-Frank act. The Dodd-Frank act put in place additional requirements for systemically important banks with the goal of placing checks and balances on their banking activities. As part of the requirements, banks were forced to run stringent stress tests to model their ability to remain solvent in a variety of market conditions. One implication from the passing of Dodd-Frank is that there exist financial institutions with businesses so intertwined with the global economy that they must remain in business to preserve national security. The government thereby rubber stamped the phrase “too big to fail.”

In 2018, under a new administration, significant portions of the Dodd-Frank regulations were rolled back. Systemically important banks were reclassified from any bank with total assets in excess of $50 billion to any bank with assets greater than $250 billion. Fast forward a few years, and a global pandemic, economic closures, inflation, and subsequent interest rate hikes have caused quite a bit of instability in global markets.

Now, banks are staring down the barrel of significant re-pricing of the assets on their balance sheet due to the Federal Reserve’s actions. This is an over simplification of the contemporary economic state of play, but it frames the general feeling of uncertainty that is percolating globally.

What does a modern bank run look like?

Today, deposits can be transferred in and out of accounts without stepping foot in a bank branch. In fact, many young people have never been inside a bank branch or written a paper check. The mobile banking apps are quite good, for the most part, at facilitating the transfer of money, paying credit off, and monitoring assets. Indeed, part of the banking industry’s value add for retail users over the last decade has been the enhanced set of features baked into these mobile apps.

However, a downstream effect of high usability in mobile bank apps is that the friction to prevent customers from exiting is essentially gone. A depositor can complete most types of bank transfers from their phone if they are able to locate their banking information in the app, conduct dual authentication, and initiate the transfer.

It’s been reported that Silicon Valley Bank (SVB) depositors withdrew $42 billion before noon on March 8th. It took just a few hours for SVB to transition from a going concern to insolvency. When reporters rushed to SVB branches to catch a glimpse of the long lines of disgruntled bank customers screaming at the unfortunate bankers, no such lines existed.

The money had been moved silently on phones, laptops, and tablets.

More context…

The SVB bank run is the second largest in US history when measured by the market capitalization of the bank at the time of the run. In 2008, Washington Mutual had about $300 billion in assets and failed after customers withdrew $16 billion over the course of 8 business days.¹ The largest bank run in history seems like a slow drip when put side by side with the SVB run. The SVB's withdrawal event was 2.6x larger in dollar terms and it happened in 1/16th of the time.

What occurred to SVB may well be the world’s first completely digital bank run.

It’s helpful to add a bit more context here about the type of depositors at SVB. SVB was responsible for banking the most tech-forward industries backed by Venture Capital (VC) funds and sophisticated investors. In fact, SVB often took bets on the companies that their depositors were running alongside the VCs. Part of SVB’s pitch to startups was that they were a tech focused bank with white-glove services.

Startups often rely on their VC investors for guidance when it comes to providing corporate infrastructure for their company’s business plan. After discovering that SVB had large unrealized losses embedded in many of its investments assets it was holding, VCs implored startup executives to move their funds to the more well capitalized large banks.

In short order, the digital hornets nest of social media (i.e. Twitter) was jolted and panic began to spread. VCs with large followings began shaping the early narrative of the SVB’s insolvency. The combination of the panic and near 0 costs of withdrawing funds, opening a new bank account, and depositing those same funds brought a swift end to SVB. The FDIC was quick to step in and begin the process of backstopping losses and sorting through the disaster.

What’s going on behind the scenes with digital transfers?

There are a few ways to transfer funds from one bank to another domestically. The banking system, like most complex digital networks, uses common languages to communicate information seamlessly across separate entities. Each of the below flavors of digital transfers has a specific protocol with built-in anti-money laundering technology to mitigate fraud.

Electronic Fund Transfers (EFT) are a digital transfer of funds that can be used to move money from a checking account to a savings account (internally) or between banks (inter-bank or externally). These payments can be set up to transfer funds automatically between accounts. Internal EFTs are effective (settle) instantly if the accounts are already linked. External EFTs can take up two business days to settle.

Automated clearing house (ACH) transfers are the most prolific form of money transfers. ACH rails have been moving money for over 40 years. In 2021, the ACH network facilitated 29.1 billion transfers for a total of $72.6 trillion.² ACH is a type of EFT that batches transactions together for expedited settlement. Same Day ACH services settle 4 times daily and are offered at most digitally integrated banks. This is the preferred method of moving large sums of money for most corporate entities and likely the tool used by many depositors fleeing SVB.

Wire transfers are another method of moving money between banks. The term “wire” refers to a time when banks relied on telegraph wires to carry the information that ultimately updated bank ledgers. There is a fee attached to this service, but wires generally settle in the recipient’s bank account the same day they are initiated.

The newest addition to the menu of the bank transfers is the Real-Time Payment (RTP). Launched in 2017, RTP is a network that allows instantaneous transfers between banks 24/7 including bank holidays. RTP is the first new transfer network to be launched in the US in the last 40 years. A RTP transfer permits enriched context to be added to payment descriptions which allows more data to be appended to each payment. Many companies use the RTP system to complete payroll payments and remit insurance premiums on an automated schedule.³

Peer-to-peer transfers are another way funds can be moved between accounts. Some examples of peer-to-peer transfers include: Venmo, CashApp, Zelle, Paypal, etc. There can be some fees associated with this type of transfer. Though these transfer methods have gained in popularity for consumers, corporate entities typically opt for more secure transfer methods like ACH or wires.

Here is a condensed list of the payment networks at this disposal of depositors:

Source: Modern Treasury. What is RTP?

The banking industry is composed of thousands of entities each competing for a share of the available deposits. This competition is generally a good thing for consumers because it enhances the end product and forces market participants to price their product competitively. As shown above, there is a reasonable amount of ways to transfer funds from one bank to another for relatively low costs.

The downside for the banks is that it is easy for customers to use a mobile banking app! An executive with corporate credentials in hand can move their company’s assets from one bank to another with relative ease and faster than ever before.

Why does the velocity of the modern bank run matter and what can we do about it?

The highly public nature of these bank failures likely means more regulation is coming. Politicians will certainly consider reinstating some of the Dodd-Frank act to place tighter controls on not only the large, systemically important banks, but also the medium and small banks. Cross-border information proliferation is ubiquitous today, and the butterfly effect juiced by panic and fear has never had more potential energy.

I propose offering special FDIC protection for bank accounts solely used for payroll or insurance payments. That may be a good place to do some of the early, regulatory spadework in the wake of this episode. These types of bank accounts are vital to any organization, and not meeting payments for these programs could expose employers to legal action against them. The insurance of these accounts by the FDIC could give companies time to determine the solvency status of their bank before rushing to the conclusion that a full withdrawal is necessary with doing the proper due dilligence.

It’s possible that regulators are going to demand that banks create more sophisticated methods for monitoring deposits and the likelihood of bank runs in real time. In a more dystopian sense, regulators may request additional customer data to build their own deposit frequency dashboards to seek the optimal grip on the banking industry’s pulse. Either way, this means additional disclosures and sweeping overreach from your bank for the purpose of collecting more data on your financial history and preferences.

The smoke that became the SVB fire was first visible publicly on Twitter. Individuals with large social media followings and real-world influence over companies of various sizes coalesced around a complete lack of faith in SVB. In the future, it may not be as easy to detect large-scale efforts supporting this type of behavior. If social media decentralizes and new social media apps with enhanced privacy settings come to the fore, it may be more difficult to identify which entity is being targeted in a coordinated manner.

Over the last couple of weeks, we have witnessed a stark reminder that depositors expose themselves to risk when placing their money with a bank. This risk is commonly known as counterparty risk. In its essence, it is the risk that your trading partner does not fulfill their obligation in any given trade or deal.

We deal with counterparty risk implicitly whenever we interact with the fiat dollar system backed by the government. We often do not think about the level of distributed faith that is needed to maintain the structure and order of the fiat system. It’s unsettling to stare entropy in the face, but it necessary when fiat systems fail.

Luckily, we have an exit ramp to the fiat system: Bitcoin. This asset is global, censorship-resistant money that is not controlled by any state. Bitcoin can be stored by its owner which eliminates counterparty risk. When analyzing your portfolio and your appetite for risk, it is worth identifying the amount of counterparty risk that you are willing to be exposed to. Given recent bank failures, I would venture to guess that most people are not willing to expose 100% of their assets to the fiat banking system and the associated risks.

1. Office of Thrift Supervision. "OTS Fact Sheet on Washington Mutual." https://web.archive.org/web/20081001163230/http://files.ots.treas.gov/730021.pdf

2. NACHA. “ACH Network Sees 29.1 Billion Payments in 2021, Led by Major Gains in B2B and Same Day ACH” https://www.nacha.org/news/ach-network-sees-291-billion-payments-2021-led-major-gains-b2b-and-same-day-ach

3. Modern Treasury. “What is RTP?” https://www.moderntreasury.com/learn/what-is-rtp