How to prevent a new banking crisis
Social media has undermined the trust that banks have always relied upon. Radical change is needed
The demise of First Republic won’t have come as much of a surprise to anyone.
Its shares had been under sustained speculative attack for weeks, and even though some of the largest financial institutions in the US tried to prop it up, it had clearly lost the confidence of depositors. By last weekend, it could no longer survive by itself, and the Federal Reserve arranged a quick sale to JPMorgan, a bank that is increasingly taking over most of the financial world.
We can add First Republic to the list of bank failures that started with Silicon Valley Bank earlier this year and spread to Credit Suisse. Whether the mini-banking crisis of 2023 ends there remains to be seen, but it would hardly be a great surprise if one of the major eurozone banks were next.
True, there are individual explanations for what went wrong in each case. Silicon Valley expanded too rapidly and made a bad call on interest-rate rises. Credit Suisse had been in trouble for years and hit by a series of scandals, so when speculation started it was always likely to be in trouble. First Republic was caught out by the cheap mortgages offered to wealthy customers, triggering big losses as money started to become more expensive again. And yet there was also a thread that was common to all of them: the speculation against each bank started on social media.
A study from economists at James Madison University published last week confirmed what we already suspected – that social media, and especially Twitter, played a big part in the downfall of Silicon Valley Bank. The authors’ analysis suggests that other banks face similar risks. SVB was, of course, uniquely vulnerable to a Twitter-based bank run. As its name would suggest, it specialised in holding deposits for the California-based tech companies. The tech community is exceptionally well networked and used to sharing information online. Once speculation started that the bank was in trouble, there was no way it could be contained.
SVB is hardly unique, however. Everyone is now online, and everyone is using social media. Speculation about the safety of any bank could come from anywhere. We are lucky it has not happened yet in this country. After all, most of the challenger or app-based banks are not yet very profitable, and many are still making losses, suggesting that they are not exactly 100% safe. A social-media scare followed by a bank run could happen at any moment. All it takes is for a few rumours to get started on Twitter and everyone will rush for the exit.
One tweet from disaster
The reality is that social media has made traditional banking impossible. All banks rely on confidence to some degree. They collect deposits, and they lend out more money than they have in deposits, or they invest it in other instruments, on the assumption that only a small percentage of their customers will take their money out on the same day. So long as everyone trusts the bank, it is a good model, and one that can make a lot of money if you get it right. But as soon as confidence evaporates it becomes impossible to sustain. It doesn’t even matter very much whether there is any basis to the speculation or not. Once it has started, everyone has an incentive to get out before the bank closes.
Speculative rumours have always been a problem for banks but before social media, it was far less easy to spread information. There were only so many people you could tell in person, and a newspaper would not print it without checking whether it was true or not. No one on Twitter checks for accuracy, and information flies around the world in an instant. A bank is always going to be just one rogue tweet from disaster.
We have to recognise that the internet has changed the way banking operates. The only real option is to have centralbank guaranteed deposits, and to separate that off from lending, so that any money you put into a regulated bank account is 100% guaranteed. Without that kind of assurance, the economy will just become even more unstable than it already is.