Cashless and Careless: Digital Payments and Silent Bank Runs

Mobile payment, facilitated by services like Chase QuickDeposit and Citi Electronic Check Deposit (ECD), has exploded recently. It’s estimated that for the last seven years, online banking enjoyed a 4 percent annual growth rate, with 66 million households entering the fold. Since 2009, the number of FDIC-insured institutions operating declined 4.8 percent, down to 94,725 banking offices nationwide. Physical currency printing rates have actually declined. This trend towards online banking has streamlined personal finance. Americans can now pay their bills and transfer money with little hassle, saving much time and energy.

Yet, with greater ease of transactions comes heightened risk of financial ruin. Cashless interactions allow money to dash across the country with the touch of a button, which accelerates the speed and depth of bank runs. In huge swoops, millions of creditors can either withdraw large sums of money from banks’ deposits at the same time, or switch to different lenders with remarkable ease. If banks don’t have enough cash on hand, there’s a high chance that customers can’t withdraw money from ATMs. That has created a recipe for banking disaster—and regulators haven’t yet smelled the fumes.

Comparing banks runs in the past to those of today offers insight into growing risks. The Great Depression’s pain intensified from 1929 to 1933 as more and more people withdrew as much cash as possible from their banks. In the first three years of the Depression, nearly 6,000 banks closed up shop after depositors felt unsafe about banks’ stability. But many obstacles—including long waits in lines and in-person (as opposed to online) transactions—slowed down the rate at which banks bled capital. Economists call these “noisy runs,” which occur when depositors literally sprint down to banks and stand in line to grab cash. By contrast, in “silent runs”, depositors transfer their funds to another bank; these runs are almost invisible, and nowadays are often done electronically.

Compounding this, banks, especially in Europe, have their balance sheets weighted heavily towards illiquid assets (equities, treasuries, property, corporate bonds, etc.). For instance, JPMorgan, the biggest U.S. bank by assets, is required to keep a mere 4.5% of its assets as cash. Smaller banks tend to have even lower requirements since the impact of their failure is not quite as dangerous. In the event of a crisis, banks like these will have little cash on hand, and are forced to either sell off investments or beg the government for capital to keep up with consumer demands. But since the economy would likely be crashing in the event of a bank run, the future value of banks’ assets would shrink dramatically as well. So with banks getting limited cash for their assets, there would be a cash squeeze, leaving banks unprepared to handle runs on their deposits.

To be sure, the movement towards a cashless society does more good than harm. Beyond speeding up commerce and eliminating day-to-day personal finance headaches, it can also stem illicit crime on a massive scale. Economist Kenneth Rogoff champions the elimination of paper money (or, at the very least, large denomination bills) from the economy. Around 80% of greenbacks in circulation are $100 notes, and they play a critical role in underground criminal networks’ financial dealings. As Rogoff has summarized, “Hoarders and tax evaders would find small notes proportionately costlier to count, verify, handle and store.” A million dollars in hundred-dollar bill fits into a duffel bag, weighing 22 lbs. With only ten-dollar bills, that jump to 220 lbs. Scaled up, it could potentially become five to ten times more difficult to transport hidden, untaxed cash.

With all the benefits that come along with cashless banking, our best bet is building a series of fail-safes into the banking system to mitigate these negative aspects. Former Treasury Secretary Tim Geithner recently summed up the role of monetary and fiscal policy to avert contagion crises from panics: “Once a run starts and the risk of financial collapse grows, the challenge is to break the panic by reducing the incentives for individuals to run from financial institutions and for financial institutions to run from one another.”

That has created a recipe for banking disaster—and regulators haven’t yet smelled the fumes.

The most common fix suggested deals with raising government-insured guarantees on bank deposits. So far, only Ireland and Denmark guarantee all deposits to savers. The FDIC currently insures up to $250,000 on deposits in the event of a bank failure, as it has since 2006. Nearly one out of every five Americans, however, has savings above $250,000. That’s about double the proportion from 2006. Every ten years or so, since the U.S. established the FDIC in 1933, we have increased deposit guarantee limits. Since about 70 percent of outflows in the 2008 crisis came from uninsured deposits, setting our threshold higher to boost creditor confidence would appear be prudent. When regulators noticed this phenomenon in 2008 as banks hemorrhaged cash, they instituted the Transaction Account Guarantee (TAG) program that insured an unlimited dollar value on non-interest bearing accounts. Dodd-Frank also enabled the FDIC to fully cover creditor withdrawals from “Systematically Important Financial Institutions” (or SIFIs). So raising guarantees much higher has been tested, and it worked as a painkiller during the crisis.

But many have decried the program and breathed a sign of relief when it expired. Publicly subsidizing the mushy balance sheets of banks carries significant moral hazard: it merely encourages the risk-taking ventures that helped precipitate the 2008 financial crisis. Raising capital requirements best balances the imperative to reduce system risks with our aversion to subsidizing Wall Street. Since Basel III, regulation that emerged from the international Basel Committee on Banking Supervision, the leverage ratio for banks has been pegged at 3 percent. The Committee found this a reasonable basis to meet stress test requirements, which process how banks perform under a series of complications, like higher unemployment, an equity market crash, or interest rate hikes. But even this buffer is too thin; analysts estimate they need 5% of reserve cash to produce stability without cutting off credit too drastically.

Regulators have proposed so-called “brake mechanisms” to prevent withdrawals beyond a certain percentage of a bank’s deposits, but they seem ill-equipped to handle quantum leaps being made with electronic banking. Economists at the Federal Reserve Bank of Atlanta suggest incorporating “planned downtime” into 24/7/365 banking. With a least a small window of time set aside for a halt on transactions, bankers can have a momentary pause during a bank run to regroup. Switzerland, South Korea, South Africa, Chile, the UK, China, India, Poland, Sweden, Denmark, and Singapore all operate on 24/7/365 schedules. Consumers do not really need true around-the-clock ability to make withdrawals. Even if they do, their need does not outweigh the risks come along with it 24/7 scheduling: potential for continuous outpouring of deposits, with no moment of respite for bankers to manage the draining.

As the National Automated Clearinghouse Association (NACHA) explains, a dollar threshold per transaction may help mitigate hyper-bank runs as well. NACHA reports, “Faster velocity of payments is expected to introduce risks that must be managed and mitigated.” Such buffers give customers pause in moments of panic—they allow us to tame our animal spirits and settle down. They keep us from making totally rash decisions, and keep the economy from imploding. Any measure to delay bank runs must be automatic in nature; no one can reasonably track the withdrawals by eye to monitor and shut down the system.

Digital transactions do boost the efficiency of banking, lending, and commerce overall. Nations like Sweden have reached 80% card-based exchanges; nearly no one carries cash any more. The Swedes themselves proudly tout, “even children pay with debit cards.” In Kenya, too, mobile apps like M-PESA have become a primary mode of payment, allowing people to text money to each other. However, the previously discussed risk and dilemmas associated with cashless banking have to be considered alongside plans to make its usage universal.

Everyone is euphoric about what lies ahead in the cashless economy, and they should be. But we should not step forward with our eyes shut, hoping that an invisible hand will guide us in the right direction. With our eyes on the prize, regulators must demand higher liquidity from banks as they face greater risks of runs, and consider safeguards to mitigate risks. We should continue riding the cashless finance wave—but keep lifeguards onshore so we don’t drown when the surf gets choppy.

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