Banks Face New Era Of Run Risk In Always-Connected World

Maybe it’s a dearth of other bad market news to monetize, maybe it’s a genuine effort to keep investors apprised of contagion risk or maybe it’s both, but the financial media is obsessed with First Republic this week.

On one hand, the blanket coverage makes sense. First Republic was the domino that didn’t fall during last month’s regional banking turmoil in the US, but it’s still teetering, and the country’s largest banks have $30 billion tied up in there thanks to what some observers, including Lloyd Blankfein, described as an ill-conceived effort to restore fragile confidence.

The bank reported earnings this week, and deposits were lower than expected — by a lot. First Republic didn’t take any questions on the call, which some found unhelpful. Media reports on Wednesday said the bank’s advisors are now trying to convince Wall Street to buy bonds from the ailing lender at above-market prices, or else “face roughly $30 billion in FDIC fees when First Republic fails.” That’s according to CNBC, whose reporting suggested the same advisors believe they can convince other investors to purchase new First Republic stock if only Wall Street will first buy bonds for “more than they’re worth.” (Bloomberg reported something similar.)

It’s absurd, but it’s a circus, and people like circuses. If you’re the media, it helps that First Republic catered to wealthy clients. Businesses with wealthy clients make for good piñatas when they (the businesses or the clients) run into trouble (see Bloomberg’s lengthy piece on the bank’s interest-only loans to borrowers in America’s “richest enclaves”).

On the other hand, First Republic isn’t really that important. That’s not to say the psychological impact of a prospective First Republic failure wouldn’t matter, and it’s not even to say that a First Republic failure couldn’t set in motion a chain reaction that changes the Fed’s calculus going forward, forces Treasury to bail out more uninsured depositors or both. All I’m saying is that in the grand scheme of things, First Republic is hardly a linchpin — of anything. With apologies, if it fails, it fails. (Cue the Ivan Drago memes.)

In theory, it can persist in limbo, sitting on its impaired assets, hoping for the best and living on an expensive Fed liquidity drip, but I doubt that’s tenable. Indeed, regulators were said to be weighing curtailments to the bank’s discount window access. Somebody, somewhere is probably going to crystallize losses. My guess would be they get socialized, only not in the sense that taxpayers share them, but rather that other banks do, which is precisely what the reporting mentioned above appeared to presage.

My point here, though, is that the process for First Republic would be easier were it not for the incessant stream of dire headlines and tweets. I see plenty of coverage, but I don’t see a polite acknowledgement of the possibility that never-ending speculation and wall-to-wall reporting is almost surely precipitating the dastardly selloff in the stock and also contributing to deposit flight.

Of course, the stock selloff and fleeing deposits are self-reinforcing, and together, they feed into more clickable fear. The further the stock falls and the more money goes out the door, the more media coverage there is, and around we go until the doors are closed — by regulators.

I don’t know why I bother with the chart. You know what it looks like. It looks like a crash.

We should know better than this by now. If social media had its way, Credit Suisse would’ve been forced into a rescue five months before March’s shotgun wedding with UBS, which was itself the direct result of what I continue to believe was a poorly-worded question by a television anchor (and an overzealous rejoinder from a Saudi financier).

The point certainly isn’t to absolve management or to suggest mistakes weren’t made, but there’s absolutely a sense in which we’re scaring ourselves into bank runs and then monetizing them via media coverage and social media engagement.

Don’t take my word for it, though. Instead, read “Social Media As A Bank Run Catalyst,” a 53-page academic paper by J. Anthony Cookson, Corbin Fox, Javier Gil-Bazo, Juan Felipe Imbet and Christoph Schiller, published this month.

Because I know no one is going to read the whole paper, and because this is highly topical, particularly given how quickly depositors can react in the era of digital banking, I wanted to take the opportunity to highlight the two brief passages below, which underscore the risks to the banking system in a world where information, news and rumors spread instantaneously, and deposit flight happens with the click of a mouse or the tap of a screen. The excerpts are presented without further comment.

Social media fueled a bank run on Silicon Valley Bank, and the effects were felt broadly in the U.S. banking industry. We employ comprehensive Twitter data to show that preexisting exposure to social media predicts bank stock market losses in the run period even after controlling for bank characteristics related to run risk (i.e., mark-to-market losses and uninsured deposits). Moreover, we show that social media amplifies these bank run risk factors. During the run period, we find the intensity of Twitter conversation about a bank predicts stock market losses at the hourly frequency. This effect is stronger for banks with bank run risk factors. At even higher frequency, tweets in the run period with negative sentiment translate into immediate stock market losses.

We present evidence that social media did, indeed, contribute to the run on SVB. More importantly, our analysis suggests that other banks face similar risks. We collect a comprehensive sample of tweets about all publicly traded banking stocks, and analyze their content, dynamics and the social transmission of bank run ideas from investor social networks to connected networks of depositors. One core insight is that SVB faced a novel channel of bank run risk that is unique to the social media era. SVB depositors active on social media played a central role in the bank run. These depositors were concentrated and highly networked through the venture capital industry and founder networks on Twitter, amplifying other bank run risks. More importantly, SVB is not the only bank to face this novel risk channel: Open communication by depositors via social media increased the bank run risk for other banks that were ex ante exposed to such discussions in social media.

The effect that we uncover — though a modern phenomenon linked to rapid communication over social media — is one that is classically rooted in bank run models. These models have always posited that communication and coordination pose a risk to banks, especially when many of the deposits in the bank are uninsured. Increasingly, in today’s society, social media provides a means for individuals to coordinate and communicate beyond what older technologies allow. The amplification of bank run risk via Twitter conversations is a unique opportunity to observe communication and coordination that shapes a critically important economic outcome — distress in banks. Given the increasingly pervasive nature of social communication on and off Twitter, we do not expect this risk to go away, but rather, it is likely to influence other outcomes, as well.



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6 thoughts on “Banks Face New Era Of Run Risk In Always-Connected World

  1. Add the potential (likelihood?) of tighter bank regulation and capital requirements to the mix. There’s at least one “super-regional” bank whose capital looks well short of what will be required when it moves to Category 2 and can no longer exclude AOCI from regulatory capital, and I suspect a good number of regionals whose capital will be short if the threshold for Cat 2 is lowered, as some think is possible.

    Then add the CRE exposure that will play out this year, and the full-quarter NIM pressure even on deposits that don’t leave, and the universe of investable regionals looks small.

    I’ve burned many brain cells on the regional banks since SIVB. Only found two names to buy, one ended up being a one week trade, albeit a profitable one, and the other is looking like dead money. Have concluded that even if you do the work and find a name, the problem is that too many of the small regionals fall into the category of names that investors don’t “need to care about”, and the larger regionals mostly didn’t get clobbered hard enough to have outsized recovery potential.

    Until the Barr report comes out, regulatory actions are known, and the CRE/NIM shoes fully drop, I think there’s easier places to find names elsewhere in Financials.

    As for FRC, it is a zombie bank now. Like SIVB and SBNY, the ticker still flickers on our screens, but it’s just the twitching of a pithed frog.

  2. At this point buying many regional banks are speculative bets rather than as investments. Regulators need to find a way to slow things down. Maybe an enhanced insurance scheme for corporate accounts that have a 20% cap withdrawal limit per day in exchange for a higher insured cap. This way companies can always meet payroll and expenses within a week at most but it will slow withdrawals. You could make the same type of scheme available for retail also in exchange for a higher deposit threshold.

  3. Nice that we’re helping algorithms find and further accelerate problems. Pretty simple to act on that research and monitize it.

  4. Barr report

    Calls out the “tailoring framework” as impeding effective supervision.

    Recommends stronger supervisory framework. Requiring capital/liquidity “beyond regulatory requirements” for a bank with inadequate “capital planning, liquidity risk management, governance, or controls. “[L]imits on capital distributions or incentive compensation” in some cases.

    Recommends stronger regulatory framework. Revisit the “tailoring framework” including “a range of rules for banks with $100MM or more in assets”. Require “a broader set of firms to take into account unrealized gains or losses on available-for-sale securities”. Change how liquidity risk in uninsured deposits, and interest rate risk, are regulated. “Tougher minimum standards for incentive compensation”.

    Notes changes in regulations will not be effective for “several years”. No such note about changes in supervision.

    Most banks below Category 2 (<$700BN assets) have chosen to exclude AOCI from regulatory capital ratios (maybe all of them, I haven’t run across an exception yet). Run a screen and you can see which regionals might fall under the capital requirements if AOCI is included, and thus are possibly at risk for capital raise, dividend cut, buyback pause, asset reduction, growth constraint, etc.

      1. Good post!

        Some banks will tell investors tougher standards are years away, implication being that capital inadequacies will heal without need to raise capital, lower dividends/buybacks, slow growth, or (Heaven Forbid) cut executive comp. One besiged super-regional spent much of its last earnings call making that pitch.

        So whether significantly tougher standards will wait until new regulations get through the rule-making and legislative process (the “several years” Barr mentions) OR if the Fed has both the will and the power to impose them now, is important.

        Did the full Barr report offer good clues on that point? Trying to decide how fruitful reading all 100+ pages may be.

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