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Mon June 11, 2012
Three Ways To Stop A Bank Run
Originally published on Tue June 12, 2012 9:11 am
There's a slow-motion bank run happening in Europe, as depositors move their money from financially troubled countries like Greece and Spain to stronger countries like Germany.
Banks take depositors' money and lend it out. So even a strong bank is in trouble if all the depositors suddenly decide to pull their money out. A full-blown run can sink a bank in an afternoon.
Once a run starts, there are basically three ways to stop it.
1. Slow it down
In the 19th century, when bank runs were common in the U.S., banks who feared a run would have employees and relatives line up in front of the tellers and make tiny deposits or withdrawals, to pass the time until the bank closed. In extreme cases — Argentina a decade ago, the U.S. during the Great Depression — authorities will close banks altogether for some period of time, to prevent people from pulling their money out.
The old-school method of having your friends line up obviously doesn't work in the era of Internet banking. And declaring a bank holiday and closing the banks altogether is a huge move that countries only make in moments of full-blown panic, when banks are out of money. Europe hasn't reached that point yet — largely because of option two — borrowing money.
2. Borrow money
People rush to withdraw their money from the bank when they're afraid the bank is about to run out of money. So if the bank can borrow a bunch of money, that usually stops the run.
The European Central Bank has been lending massive amounts of money to European banks. And that's been essential so far in preventing a full-scale bank run in Europe. This weekend's agreement to bail out Spain's banks goes further. It's a huge pool of loans that should make ordinary savers confident that their bank isn't about to go under.
3. Insure peoples' deposits
Deposit insurance started in the U.S. during the Great Depression, and it persists today. That's why you see the letters "FDIC" on the door of every bank in the country today. It's a promise that even if the bank goes under, the government will guarantee that ordinary people get their money back. This promise alone has ended bank runs almost entirely.
There is deposit insurance in Europe today. But it's issued by individual governments. So if people are worried that the government itself might run out of money, even deposit insurance may not be enough to prevent a run.
"The problem we have today, is that the Spanish guarantee is looked upon by Spaniards as maybe yes, maybe no," says economist Charles Wyplosz. "That's not the kind of risk you like to take with your money." The problem is even more acute in Greece.
One solution that's been proposed: Deposit insurance that's backed by the entire eurozone. In that case, depositors in Greek and Spanish banks would know that their savings were guaranteed not just by their own governments, but by Germany and other, more financially sound governments.
Of course, this would also leave taxpayers in Germany (and every other eurozone country) on the hook for the behavior of banks throughout the continent.
RENEE MONTAGNE, HOST:
Finance ministers from the eurozone nations agreed over the weekend to lend Spain up to $125 billion. The aim is to keep the country's banking system from imploding and going the route of Greece, where an almost full-scale bank run is underway. NPR's Zoe Chase from our Planet Money team explains the three main ways to prevent a bank run.
ZOE CHASE, BYLINE: A run can sink a bank in an afternoon. That's why everything about a bank is designed to avoid panic. Vaulted doors, boring-looking guys in boring-looking suits with boring ties; big, solid, fancy-looking buildings; really big lobbies, so a line doesn't go out into the street. Once a bank run starts, though, there are these three ways(ph). Liaquat Ahamed is a banking historian. He says the first one, slow it down.
LIAQUAT AHAMED: One of the age-old techniques is to get people to line up and withdraw 10 cents from their bank. And if you get enough people coming in the line and just withdrawing tiny amounts, that means that the line is incredibly long and it slows it down.
CHASE: Banks once used their own employees and relatives of their employees to stand in line and count out their change. Then 5:00, boom, the bank's closed. The president of the bank would call around that night looking for cash.
AHAMED: Just when everyone's lining up the next morning, a truck pulls up with bags of gold and everyone says, oh, wonderful, there's money in the bank, and they all go home.
CHASE: That's pretty much what Roosevelt did, FDR, when the United States faced a huge run on its banks. His first act as president in March of 1933, he shut all the banks down. Then he told everyone he'd done it.
(SOUNDBITE OF ARCHIVED RECORDING)
UNIDENTIFIED MAN: Ladies and gentlemen, the president of the United States.
PRESIDENT FRANKLIN ROOSEVELT: My friends, I want to talk for a few minutes with the people of the United States about banking.
CHASE: While the banks were closed, Roosevelt employed the second technique: borrow money. He expanded the Federal Reserve's ability to lend money to the banks, and he shipped the new cash all over the county. Next, number three on our list of how to stop a bank run: insurance. Roosevelt created the FDIC, letters you see on the door every bank in the country today, promising that if this bank goes under, the government will pay you back.
AHAMED: And the amount they insured was tiny. It was deposits up to $2,500.
CHASE: These tactics worked. There hasn't been a nationwide bank holiday in the United States since, and the insurance rarely pays out. Today it's up to $250,000. So to recap, in order to stop a bank run, you slow it down, you borrow money, you insure deposits. Now, is any of this useful for Europe? In today's banking system, you don't have to be in the bank to make a run on it.
You can just quietly transfer money into another country, as has been going on in Greece. What about the second trick, borrowing from the Central Bank? The problem here, there is no European-wide banking regulator that the European Central Bank could work with to expand its lending powers, like there was back in Roosevelt's time. So the ECB is reluctant to do more lending that it already is. What about the last trick, insurance? In fact, Spanish bank deposits are guaranteed by the Spanish government, but...
AHAMED: In order to do that, you need to have the cash, that's the problem we have today, is that the Spanish government guarantee is looked upon by Spaniards as maybe yes, maybe no, and that's not the kind of risk you like to take with your money.
CHASE: Economist Charles Wyplosz says you've got to trust the government for a government guarantee to work. Certain broke European governments not so easy to trust. There is no European-wide deposit insurance that promises to pay you in euros no matter what. No yet, anyway. There is no one leader sitting by one big fireside to talk to one European people and say something like this.
(SOUNDBITE OF ARCHIVED RECORDING)
ROOSEVELT: You people must have faith. You must not be stampeded by rumors or guesses. Let us unite in banishing fear.
CHASE: Zoe Chase, NPR News. Transcript provided by NPR, Copyright National Public Radio.