Bank run(s) CBDC Banking ≠ Fractional Banking
A look at systemic risk of leveraged fractional reserve and new banking using CBDC
This is a long essay in which we elaborate on a simple thesis: Central Bankers are unlikely to be able to understand and regulate digital banking, where 40 billion dollars of deposits can rush out in 6 hours. Money, credit (leverage), and trust are related in finance, and the market discovers new methods faster than regulators can understand or manage.
The essay is lengthy because we provide context and links to bring readers with different levels of awareness to the same level of facts or data. Please skip sections that you are familiar.
Suggested reading sections:
1 Synopsis
My personal bank run experience and suggestion on a new digital bank different from fractional banking and too big to Bail and too small to Fail banks.
We can assume main drivers for bank runs in March 2023 were:
- Poor Risk management by an Individual bank or banks
- Dis-loyal or ‘bad’ customers.
- Poor macroeconomic policies. ZIRP for decades?
- Regulation and regulators failure. Sleeping on the wheel and inadequate appreciation of a sharp increase in interest rates
Basel III and Dodd-Frank approach post-2008 GFC regulation considerably tightened risk management in individual banks. There are many comments on basic mistakes in asset-liability matching and concentration on some dodgy industries like VC & Startups or crypto. The discussion also needs to consider if central bankers have tools to fight inflation dominated by the supply chain, and the threshold rate should be higher at 3% for USA. In sections below we quote
El-Erian chief economic adviser at Allianz SE Raghuram Rajan ex-Governor RBI and Professor of Finance at Chicago Booth
G N Bajpai ex-Chairman of the Securities and Exchange Board of India and Life Insurance Corp of India
3 Regulation and Regulators may dominate in creating systemic risk
A list of points:
- Archaic computer back-ends have a 4 PM cutoff, which prevents them from sending emergency loans of 20 billion to SVB before its closure.
- Since late 2021, there have been around 20 supervisory staff members at SVB. There have been notices of poor management by summer 2022, but no action was taken.
- FAS 157 mark-to-market was abandoned in March 2009, so FASB/IFRS allowed HTM (held-to-maturity) losses in footnotes. Many banks switched from Available-for-Sale (AFS) to HTM to hide rising losses.
- Risk-adjusted solvency and liquidity stress tests forced harmonization across banks, leading to more system-level fragility.
- Aggressively raising interest rates could have a much greater impact on banks than a hammer blow.
- Surprisingly, the existing stress test of the Fed may have still passed SVB as being compliant in February 2023.
4 Fractional Banking is Leveraged and fragile.
It is well known that bank deposits are used to fund loans and other ‘risky’ activities in the hope of far better social benefits from the ‘costs’ of some bail outs. The size of bailouts will increase for example Credit Suisse backstop is 1/3 of Switzerland’s GDP. This section explores the issue and a guess of cost of bailouts as 0.25% of GDP
5 Re Imagine Banking in a Polycrisis
Considering various factors such as geopolitics, war, changes in consumption, and investment post-COVID, a new type of banking that utilizes CBDC and incorporates lessons learned from 24X7 crypto (even on banking holidays) should emerge. Additionally, #defi has proven to be effective during times of economic collapse, such as the Lehman moments and GFC types. Focus on currency as a method of exchange and delink store of value to provide new zero or low-interest bank accounts (Narrow Banking) where the deposits are directly with the central bank as its monetary base. The non-interest-bearing digital banknote e-Rupee of RBI is a possible approach. Also, consider other methods to support mortgage and development financing using ultra low cost mutual funds and incentives for risk assumption with differential pricing , tax and interest charges. The massive adoption of ‘free’ UPI is a good example.
Originally published at https://arvindsang.notion.site.
