Teaching Tip #1 "Classic Bank Run” Led to Historic Bank Failures | April 2023

April 2023 | Volume 14, Issue 9

Read the full article from CBS News.

According to the article, the startling collapse of two major banks — Silicon Valley Bank and Signature Bank — was caused by a "classic bank run," Gary Cohn, vice chairman of IBM and director of the National Economic Council under the Trump administration, told the media.

"We had a situation where people got scared about a bank's ability to return depositors' money and depositors wanted their money out," he said.

Cohn said a bank run in the present day looks different from what we might expect. With electronic banking being the norm, people can easily and quickly withdraw funds at the touch of a button.

"Today, a bank run happens on your telephone," he said. "People electronically bank. They hit the buttons on their phone. And automatically they can take all the money out of the bank. Banks are not designed to have deposits leave instantaneously."

The historic bank failures have raised concerns about the stability of financial institutions and raised questions about a 2018 law that relaxed regulations on small banks. The law was designed to reduce the regulatory burden on smaller banks and financial institutions, while still maintaining important safeguards to protect consumers and maintain the stability of the financial system.

But critics questioned whether the legislation weakened the government's oversight of regional and smaller banks.

Cohn, who was former President Trump's economic adviser when the Economic Growth, Regulatory Relief, and Consumer Protection Act was passed, said that nothing in the 2018 measure would have impacted the collapse of Silicon Valley Bank.  

"At the end of the day, it didn't have to do with capital. Capital is the ability to absorb loss. So nothing that was done in 2018 would have affected the outcome here," he said. "What affected the outcome here is the fact that no banks hold enough cash that when all the depositors want their money back simultaneously, they don't have it."

Banks are required to maintain a certain amount of capital and liquidity. The liquidity ratio measures a bank's ability to meet its short-term obligations, such as customer withdrawals, without needing to sell off assets, Cohn explained.

As financial regulators and lawmakers examine the collapse of SVB and Signature, the crisis has raised concerns about the stability of regional banks as well as the broader U.S. banking system. But Cohn said FDIC insurance was created to protect depositors when lenders fail. 

"The reason FDIC insurance was created is to protect your mom and my dad, to make them feel comfortable to leave their money in a bank, knowing it's secure, because a government agency is providing the insurance that they need to make sure their deposits are there when they want them, and the process is working," he said.