Tuesday, June 25, 2013

Insider bank runs

Bank runs occur when depositors believe a bank is insolvent. They rush to withdraw their deposits before everyone else as funds dry up. Who is first in the queue at the wicket? When such panics break out, they must originate somewhere, whether justified or not. In particular, somebody must have had some privileged information that there is a problem with this bank. I doubt bank runs start as the bank releases its latest numbers and everybody is surprised.

Rajkamal Iyer, Manju Puri and Nicholas Ryan got access to the deposit withdrawal logs from a bank that has been subject to two runs. The last one is particularly informative, as a regulatory audit found the bank insolvent, and despite this information being private the bank run ensued. It is then no surprise to see bank employees as the first ones to withdraw their funds, followed by depositors with uninsured funds, who are the most vulnerable and may have been tipped off by some employees. Insider information appears unavoidable and leaks to the public. It appears difficult to avoid a run when a bank is indeed insolvent, unless it comes as a sudden development over the week-end. As a policy maker, this means that you better make sure banks never become insolvent, or you end up always insuring the bad risks, those that do not have insider information.

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