Tech is increasing systemic risk by accelerating bank runs, Bank of England warns
Tomorrow’s financial crisis could unfold at a speed that no human policymaker could ever hope to contend with.
In the not-so-distant past, the potential damage of a bank run was limited by the need for savers to physically withdraw their deposits. Here in the UK, this was vividly illustrated when Northern Rock collapsed in 2007 and queues of anxious savers formed outside branches across the nation.
Today, however, a bank run is likely to be much faster due to the rise of digital financial services, posing a major systemic risk and potentially causing a cascading crisis that quickly slides out of the control of governments and central banks.
In a speech delivered earlier this month called "Planning to Fail", Ruth Smith, Executive Director, Resolution, at the Bank of England, warned that the failure of Silicon Valley Bank in March 2023 shows that the ease of withdrawing deposits means tomorrow's financial crises could unfold at a terrifying pace.
She said: "The speed at which modern bank runs can occur should not be underestimated. Technological change and faster information dissemination can leave institutions vulnerable to very rapid runs, with deposit outflows significantly exceeding historical rates.
"This can leave authorities with a matter of days to execute a resolution."
The demise of "too big to fail"
After the financial crisis of 2007 and 2008, the Bank of England feared "contagion" and introduced new rules to limit the risk of failure spreading through the financial system.
Among the prudential and macroprudential reforms it instituted were resolution mechanisms, leading to the temporary Banking (Special Provisions) Act 2008 and the Banking Act 2009, which were intended to reduce the threat that collapsing banks could pose to the wider economy.
The G20 then launched a Financial Stability Board, which introduced a sweeping reform agenda intended to end the doctrine of “too big to fail” and ensure failsafe systems would allow large banks to collapse without dragging the global economy down with them.
"Resolution frameworks are not designed to prevent a firm from failure but instead to preserve its critical economic functions and mitigate contagion from disorderly liquidation," Smith explained in her speech.
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In the UK, regulators have various ways of reducing systemic risk. For instance, they have set three main ways to handle a failing lender: forcing debt-for-equity restructuring through a “bail-in”, selling the business to a private buyer or a temporary Bank of England-run bridge bank, or allowing it to enter a special insolvency process that prioritises paying back depositors.
Additionally, firms at risk of requiring resolution and facing a bail-in are required to hold extra loss-absorbing capital under so-called MREL (minimum requirement for own funds and eligible liabilities) rules.
This policy means banks effectively insure themselves against failure by holding funds that can recapitalise the organisation, giving it a chance to rebuild and restructure rather than crumbling to the floor and pulling down other institutions with it. These rules are limited to the largest and most complex institutions - typically those with more than £40bn in assets.
Financial collapse at machine speed
However, the sheer speed at which bank runs now occur could test these frameworks like never before, meaning the Bank of England is continuing to adapt and refine its safeguards in response to the evolving risk.
"A significant amount of work has been undertaken to strengthen the UK’s approach to banking failure and resolution," Smith said.
"However, future crises may not resemble those of the past. "Risks are evolving alongside the external environment.
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"Large-scale changes in technology and the rise of internet banking facilitate quicker deposit outflows, social media increases the speed at which uncertainty and instability can propagate, there is more private credit than ever before, and the cross-border payments landscape has evolved significantly."
Financial chiefs are now urgently considering updates to resolution schemes and other measures designed to prevent contagion and improve systemic resilience.
"The Bank of England recognises the importance of adapting in line with a changing world and will continue to iterate our regime as appropriate."
In a world of instant withdrawals and viral panic, the challenge for regulators is no longer whether banks can fail – but whether humans can still move fast enough to stop the damage spreading.
