The evolution of the bank run — Part I by Claudio Grass
There are numerous and wide-ranging reasons why someone may choose to invest in physical precious metals. A deep understanding of monetary history provides plenty of solid arguments, and so do the mounting geopolitical risks, the spiking probability of a recession and the long-term goal of many conservative investors to safeguard their financial self-determination. For me, while all of these reasons are important, there is also another argument that I find especially powerful and extremely relevant today. The vulnerability of the current banking system itself is a risk that is often overlooked or dismissed, as most mainstream investors, having short memories and a narrow attention span, tend to believe blindly in the banking sector’s ability to protect and preserve their assets and their savings.
A clear and present danger
For most people, the very idea of a bank run is quaint and anachronistic. It conjures up black-and-white images of 1929, and it harks back to the old fears of the analog times. Today, they think, these risks are a distant memory and nothing for the modern investor, or bank customer, to seriously worry about. We have sophisticated systems in place, strict regulations in the banking sector and computers that cut out emotional impulses and smoothly control everything. Surely, banks are safer than ever. And yet, nothing could be further from the truth. Bank runs, far from being a thing of the past, still present a very real risk. Customer confidence can collapse as easily and as rapidly as it did a century ago. Any bank’s creditworthiness and reputation can come under fire and mass withdrawals can cripple any financial institution.
The most recent example of this came out of China in early November and Yichuan Rural Commercial Bank learned this lesson the hard way. A rumor that originated from an obscure social media account and then spread like wildfire cast serious doubts on the bank’s solvency. Panic escalated quickly and within hours of the original post, over 1,000 customers had physically queued up to withdraw their money from the bank. By the next morning, local Chinese authorities had to intervene, with over 30 billion yuan ($4.3 billion) of liquidity injections, to restore confidence. At one branch of the bank, staff even resorted to putting piles of cash on display, just to reassure customers and creditors.
The following week, a similar scenario played out once more, this time at Yingkou Coastal Bank, in northern Liaoning province. In this second bank run in less than two weeks, liquidity fears once again drove customers to line up for mass withdrawals. Arguably, events like this can be seen as just the tip of the iceberg for China’s highly vulnerable banking sector. Earlier this year, the Chinese government had to proceed with a rare government seizure of Baoshang Bank, a move that sparked serious concerns and caused a spike in borrowing costs. As a result, the PBoC itself had to step in and inject 250 billion yuan ($36 billion) into the country’s financial system. Saddled with a huge burden of nonperforming, toxic loans, in recent months, especially smaller, rural banks have also been plagued by an escalating public confidence crisis. So far, the state has provided implicit and explicit support to the lenders, with backstops and interventions, which only provides more fuel for the widespread fears that many banks are likely unable to survive on their own.
However, this risk is not contained within China alone. In late October, we saw similar issues plague banks in Lebanon. Amid widespread protests and prolonged demonstrations against the government, fears of a bank run spiked rapidly. As a result, the country’s banks remained closed for almost half of last month. Several instances have been documented of bank staff intimidated by customers demanding access to their cash, while the probability of capital controls or even a “haircut” on deposits are further fueling public anger. Despite the assurances offered by the Governor of the Lebanese Central Bank that there will be no restrictions to the free flow of money, since reopening, many Lebanese banks have imposed their own forms of capital controls. Some have placed limits on US dollar withdrawals, others prohibited clients from transferring large amounts abroad. Chaotic scenes have been taking place in bank branches all over the country, as faith in the banking sector has been severely shaken.
Lessons from the recent past
If the situation in Lebanon sounds eerily familiar, it is perhaps because it heavily resembles the situation that Greece faced, in the weeks before capital controls were formally and officially imposed. The severe economic crisis that crippled the country, brought back the ghost of “Grexit” and lead to massive protests in the streets, eventually escalated in 2015 and threatened the entire banking sector. The political and economic uncertainty of that time caused millions of Greeks to take their deposits out of the banking system and store it at home, in safes and mattresses. In 2015 alone, deposits in the country’s banks declined by 40 billion euros. After negotiations between the Greek government and its creditors took a particularly wrong turn, long queues were formed outside most bank branches, with citizens lining up since dawn to withdraw their money. Much like in Lebanon, the initial response was to temporarily close the banks, in order to prevent a complete systemic collapse caused by public panic. The government then proceeded to impose capital controls on citizens’ deposits, limiting their withdrawals to 60 euros a day. The chaos that ensued thereafter was widely covered by international media and the impacts of the policy, which only officially ended in September of 2019, are still felt to this day.
Of course, that’s nothing compared to the case of Cyprus. In 2013, after a financial crisis had hit the island and liquidity fears surrounded its banks, the government went a step further, even beyond bank closures and capital controls. The Cypriot government, with no notice, authorized a “haircut”, or “one-time tax” on bank deposits over 100,000 euros, in a bail-in attempt to prop up the country’s distressed banking sector. This confiscation, which was a key requirement by international creditors for a 10-billion-euro bailout package, had a severe impact on savers and investors who had trusted the island’s banking system. After billions were taken from their accounts, 51 of the people who lost funds pursued a legal case for compensation. The case went all the way to General Court of the European Union, were the depositors argued that the bail-in had violated their right to property. In 2018, their case was dismissed by the court, which in its judgment found that the haircut did “not constitute a disproportionate and intolerable interference impairing the very substance of the appellants’ right to property”. Many analysts have argued that the Cypriot case established a strong precedent and a new blueprint on how far governments can go to deal with financial and banking crises, while the legal verdict further legitimized the approach.
In the upcoming second part, we look at recent bank runs in Western economies that are widely considered stable and predictable, while we also examine the practical implications of modern bank run for conservative investors and responsible savers.
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