Digital bank runs sure are quick (English, 2023-03-13)

By now, you have probably heard about the bank run on the Silicon Valley Bank, which went into a formal receivership of the FDIC. As Fed funds interest rates have been going up for the past year in order to tame record inflation, it has become more enticing to place excess liquidity with the Fed. Accordning to CNN, “SVB’s $21 billion bond portfolio was yielding an average of 1.79% — the current 10-year Treasury yield is about 3.9%.”, and as is common knowledge, treasuries are the primary securities to use as collateral for central bank enabled repo financing, hence always in solid demand. So, on the margin, it makes more sense to buy treasuries to get a juicy return of capital, rather than SVB bonds with a meagre return on capital. This development has obviously weakened the fundamentals of the bank. 

However, the straw that broke the camels back was apparently the urgent withdrawal of liquidity, as is normally the case in bank runs. According to the FDIC, SVB had 175 billion USD in total deposits year end 2022. But gosh, this was really a quick one! Thursday morning, the SVB treasury was flush with digitial cash, and the next day, 42 billion USD short. Wow! That’s quick! Approximately a quarter of the deposits moved over night (or more, if FDIC data is stale). Almost as quick as turning off a switch on a PC! But then again, the cash is digital and easy to move, so it should not be that much of a surprise. And now that all our systems are based on digital assets and digital money, one can see how it could propagate rather quickly. If the ratio of potential deposits moved is representative of the banking system at large, well, to me at least it seems as if the whole thing can unravel in weeks rather than months. 

Hmm. What is the appropriate policy response to this delicate situation? It is obviously difficult to limit withdrawals, because these would be panic inducing in the sense of actually becoming a self fullfilling prophecy. But then again, increasing the amount of guaranteed deposits would probably not guarantee anything; do we really know who are behind a lot of the smaller digital depositors in our interconnected world, which could be rapidly and inconveniently withdrawn to the tune of a quarter of the deposits over night? Could this in fact be a coordinated “hybrid attack” on the US financial system? The media seems so paranoid these days, I wouldn’t be the least surprised to see some oddball journalist brandishing a like minded conspiracy theory.

No, the solution to the problem is clear: you get hold of gold to back up your financial system, if you can, just like any sane central bank has done over the last 15 years. And if you cannot, you try to build it digitally, also known as Central Bank Digital Currencies, or CBDCs. These will be credible, judging by the CBDC project Icbreaker, at least as long as the IT systems remain intact, and hopefully unbreachable.

But wait, the Riksbank just got breached, by Anonymous Sudan! Oops...