Home ›› 17 Oct 2022 ›› Editorial
Economists excel at coining words describing situations handy to both academic and general readers. One such word is bank run. The bank never runs to depositors but distressed depositors often run to the bank.to get their hard-earned cash. “ A bank run occurs when depositors suspect that a bank may go bankrupt and, therefore “ run” to the bank to withdraw their deposits. There are many examples of a bank run in global economic history.
The recent incidents of depositor heists’ in Lebanon forced bank closures. Depositors “ liberating” their money have been greeted as heroes. Lebanon is in the throes of economic pain for three years with plummeting currency and banks with tough withdrawal restrictions on customer accounts. Seven banks in Lebanon are now the target of depositor's heists’ and banks have decided to close their doors through the Association of Banks in Lebanon. Banks often exist in the embodiment of a treacherous hole that gobbled the poor man's savings. Unfortunately, in many instances the government and rich people protect them. When a bank run occurs, the banks close their doors until outstanding loans are paid or until some lender of the last resort such as the central bank provides it with the currency. Bank runs complicate the control of the money supply; households prefer to hold their money in the form of currency that impedes money creation through the banking system and simultaneously an increase in reserve ratio reduces the money multiplier.
The anatomy and physiology of bank runs are very simple. Both deficit and surplus units exist like twins in an economy. Agents who receive more money than they spend are referred to as surplus units who contribute to the financial markets. Deficit units borrow from the financial markets. The financial institution is the bridge that links the deficit and surplus units and thus works as an intermediary in the process. Financial institutes pool all their deposits in an ingot and channeled them into investments. Deficit units generally constitute firms, government, business, and corporate establishments and individuals. The private sector constitutes the main hub of the surplus unit. Depositors' money is the most liquid asset but those who borrow for investment constitute illiquid assets such as a house, types of machinery, capital equipment, and raw materials. The optimum risk in the transaction process depends on the transformation process from liquid to illiquid assets and vice versa.
Bank runs are a problem for banks under a fractional -reserve system. Scheduled banks all over the world perform their business transactions through a fractional -reserve system that entitles a lion's share of the deposits as loans or advances. All the depositors do not come to withdraw their money concurrently so the banks are comfortable with their day-to-day transactions with the streams of deposits and loans. The banks in many countries get buoyancy through the deposit insurance scheme with the central bank in hedging temporary insolvency. Federal Deposit Insurance Scheme [FDIC] in the United States guarantee the safety of deposits at most banks and depositors are confident that even if their bank goes bankrupt, they get back their money through FDIC. The counterpart in Bangladesh is the Deposit Insurance Scheme.
Like the previous year, the Nobel Prize in Economics for 2022 was awarded to a trio; Ben S. Bernanke, Douglas W. Diamond, and Philip H. Dybwig for their contribution to ‘Research on Banks, Financial Crisis’ in the field of economics. The committee noted that the three awardees have significantly improved our understanding of the role of banks in the economy, particularly during the financial crisis. One of the key insights from their research is why it is important to avoid bank failures or a bank runs. The committee underscores the importance of the soundness of the banks in mitigating the crisis and how bank failure exacerbates financial crises. The foundations of this research were laid in the early 1980s by Ben Bernanke, Douglas Diamond, and Philip Dybwig. The regulation of financial markets and their analysis is of great practical importance in dealing with financial crises. The insightful model of Diamond and Dybwig delineated the tension between an individual’s desire for liquidity and long-term investments that cannot be easily converted into cash. You cannot convert the capital cost of a bridge into the most liquid assets in just a few months or earnings in local currency in a designated foreign currency to pay your debt.
We have to admit that banks perform a crucial role by reconciling otherwise incompatible desires for liquidity and productive investment. And it normally works because only a fraction of a bank’s depositors want to withdraw their funds at any given time. A gossip on fragility of a bank run can create a havoc in the whole spectrum and during a panic the rational thing is to panic along with everyone else. The Lebanon crisis could be a clue in the filtration process in decision making process for the Nobel committee this year.
There was, of course, a huge wave of banking panics in 1930-31. Many banks failed, and those that survived made far fewer business loans than before, holding cash instead, while many families shunned banks altogether, putting their cash in safes or under their mattresses. The result was a diversion of wealth into unproductive uses. Bernanke in 1983 offered evidence that this diversion played a large role in driving the economy into a depression and held back the subsequent recovery. An effective weapon in mitigating the risk of self -fulfilling panic is to design certain equipments that could be buffer in short-circuiting the potential crisis. On the contrary, there may be issue of moral hazard in this whole epside. “Case in point: the huge costs to taxpayers of bailing out irresponsible players during the savings and loans crisis in the 1980s. So banks need to be regulated as well as backstopped.'' There are umpteenth examples of this question of moral hazard all over the world including Bangladesh.
There are not visible incidents of bank failure in Bangladesh yet the frustration of the depositors in recovering the liquid assets often cost considerable mental stress. The Basic Bank [Bangladesh Small Industry and Commerce Bank limited], a public sector bank and the Farmer’s Bank now renamed as the Padma Bank, a private sector bank are two examples. The Governor of the Bangladesh Bank [BB], the central bank in a recent disclosure identified 10 weak banks on four criteria such as classified loan limit, capital adequacy, credit to deposit ratio and the quantity of provision. The identified bank will submit a three-year work business plan and sit individually with the BB in delineating the stepwise work plan solving the problem. The sincerity and acumen of the Governor in not naming the banks is captured through this quote, “It is better to hide the names [of those banks]. If a bank is fragile, it affects others. We are not in favour of closing any bank. We want to ensure that the money of depositors will remain safe. We want all banks to run business, make profit and sustain in the market.” Let us wait and see.
The writer teaches at the BRAC University and BIDS as an adjunct Faculty in the Master’s Programme in Economics. He can be contacted at [email protected]
