Rumors circulated that up to 700 million EUR worth of deposits were withdrawn from Greek banks in a SINGLE day last week. Meanwhile, some officials were saying that Bankia, one of Spain’s largest banks which recently got nationalized, saw withdrawals amounting to 1 billion EUR last week.
Coupling this with the news that Moody’s recently downgraded 26 Italian and 16 Spanish banks and that the European Central Bank (ECB) cut-off several Greek banks from its 3-year LTRO program, it’s no wonder that fears of a European banking crisis and a potential euro zone-wide bank run have been creeping into the markets.
But before we get ahead of ourselves, lemme first explain what exactly a bank run is.
It is widely perceived that a bank is one of the safest places where you can park you hard-earned cash. Not only do they put your money in super hi-tech vaults and have 24-hour security, but you also get government insurance in case of any bankruptcy.
The problem is though, once the stability of a bank is put into question, depositors begin to withdraw their cash. After all, government insurance has its limits and there’s no telling when you’ll get your money back.
This is where everything gets really messy. Remember, the banking system works because not all of your deposits are read cash-on-hand. Banks only hold a portion of total deposits in their vaults – the rest is invested in a variety of ways, including loans to other depositors and small businesses. This is how the banking system has worked for hundreds of years and it’s proven to be effective in giving everyday consumers access to much needed funds.
However, when a bank run occurs, aside from a decrease in deposits, we also see decreased liquidity which means that there is less money available in the economy. If there is no cash to lend out, banks cannot issue loans which are critical to the success of many small businesses. Ultimately, it gets in the way of economic growth.
What’s worse is that bank runs have far more adverse effects. Some bank runs that have crippled economies were that of the Great Depression in the 1930s and the Argentinian crisis in the early 2000s.
Now, one reason why we’re seeing bank runs in Greece is that it’s on the verge of getting kicked out of the euro zone. Depositors know that should Greece exit the euro zone, they won’t be able to withdraw their money from banks to transfer to other countries. On top of that, they would have to convert their savings to the new local currency which would probably be much weaker than the euro. This means that their hard-earned money would be devalued, making their savings almost worthless.
That said, it’s no surprise that depositors are worried. People are already starting to move their money from Greece to other euro zone countries such as Germany while it’s still in the bloc. Once Greece gets the boot, it’s possible that euro zone officials to suspend the flow of capital from Greece to other euro zone countries.
It’s now a primary concern among analysts that if a bank run can happen in Greece, it’s likely that we could see the same happen to the euro zone’s larger debt-ridden countries, namely Italy and Spain.
The threat of future bank runs could lead to risk aversion as investors panic and cut back on their investments on risky assets. This is evidenced by rising government bond yields. Just last Friday, we saw Spanish and Italian bond yields go over 6% as investors worry about the solvency of governments. Keep in mind that when banks fail, governments usually step in to save them. Knowing this, investors tend to demand higher yields to hold bonds by debt-ridden governments.
So how should the threat of bank runs in Italy and Spain be addressed?
First and foremost, everyone just needs to relax and breathe. Sure, the 1 billion EUR worth of withdrawals from Bankia may seem big. However, take note that this figure represents less than 1% of Spain’s deposit base.
If worse comes to worse, perhaps the EU could implement a region-wide bank resolution regime to avoid bank runs which could include providing deposit insurance and limiting withdrawals on all euro deposits. However, the drawback to this is that it would take out the control of individual governments over their respective banks.
But I don’t think we need to worry about that for now. What we’re seeing in Spain now is not a bank run or at least not yet. Let’s just be on our toes to how the events unfold.